When you withdraw funds from an Individual Retirement Account, the Internal Revenue Service does not require the account custodian to withhold a certain percentage of the withdrawal to cover taxes, whereas withdrawals from 401k accounts involve a mandatory federal withholding of 20 percent. Many IRA owners choose to have the custodian withhold 20 percent of all IRA withdrawals, but others choose to pay the taxes at the end of the tax year.
Traditional IRAs, like 401k accounts, contain gross earnings; thus, whenever the account owner makes a withdrawal, the IRS assesses taxes on both the principal and earnings. The taxes due depend on the owner's overall tax bracket because the IRS classifies all withdrawals as ordinary income. You may leave funds in Traditional IRAs until age 70 1/2 when Required Minimum Distributions must commence. The amount of the RMD varies from year-to-year, based on the consumer price index.
Traditional IRA owners, who withdraw IRA funds invested in a tax-qualified retirement account for less than five years, have to pay a 10 percent tax penalty in addition to ordinary income tax. People below the age of 59 1/2 who access IRA funds must also pay the 10 percent penalty, regardless of how long funds have been in the IRA. IRA owners can ask the plan custodian to withhold the penalty tax, the income tax or both, at the time of distribution. Many people opt not to withhold taxes, however.
Account holders bought Roth IRAs with net earnings and, therefore, can withdraw principal contributions at any age without having to pay taxes. Those who hold Roth IRAs for at least five years and until age 59 1/2, do not pay taxes on withdrawals of principal or earnings. People who access funds before age 59 1/2 must pay ordinary income tax on the earnings, as well as a 10 percent premature withdrawal penalty. As with Traditional IRA withdrawals, Roth owners must tell the plan custodian how much to withhold.
State tax laws vary; although states generally do not have laws mandating tax withholding on IRA withdrawals, many people are required to pay taxes on IRA withdrawals at the state level. Brokers and bank employees can notify IRA owners about tax brackets, but cannot provide account owners with tax advice. In some instances, such as withdrawing money to use toward a down payment on a home, IRA owners can access funds penalty free. However, IRA owners should consult tax professionals to determine their tax liability when making any withdrawals.