How Are Retirement Withdrawals Taxed?

401(k), Retirement & Investing
on March 27, 2013

Saving money for retirement is an essential step in your financial life, but many people do not understand how the money gets withdrawn once they reach retirement. At some point, you’re going to need to start taking out that money in order to live. How big of a chunk is going to go to Uncle Sam once you take it out? That depends on your situation and what type of account you have.

Pre-Tax or After-Tax Account?

When you are trying to determine how much money is going to go to the government in taxes, you have to look at what type of retirement account you have. Whether you have a pre-tax or an after-tax account will have a huge impact on how much you pay in taxes during retirement. If you chose to go with a pre-tax account such as the IRA or the 401(k), then you put money into your account without paying any taxes on it. This means that you will have to pay taxes on the money as you take it out.

If you elected to put your money into a Roth IRA or a Roth 401(k), then you already paid taxes on the money before you deposited it. This means that you do not have to pay any taxes on the withdrawals from your account. Saving money on an after-tax basis may not be easy, but it can pay off when you hit retirement.

How Much Will Be Taken Out?

If you have a pre-tax retirement account such as an IRA or a 401(k), the amount of money that you have to pay in taxes will depend on your income. This will largely be determined by how much you take out of your retirement account. At the end of the year, you’ll add up all of the money that you took out in withdrawals along with any other sources of income you have. This determines your income for the year. Then you can figure out what your marginal tax rate is. At that point, you can determine how much of a percentage you’ll have to pay in taxes. As you take out more money, a bigger chunk will go to the government. This means that you have to be careful when taking money out of your account. You want to take enough how to live on, but at the same time, you do not want to overdo it.

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