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How Pulling Money From Your Retirement Can Make Or Break You

by Amy Psyhos

Generally speaking, when considering taking a retirement distribution from a 401(k) plan, IRA, Roth IRA, 403(b) or other qualified retirement plans before you are 59 ½ will cause you to be hit with a hefty 10% penalty on the distribution. There may be less expensive ways to take care of unexpected bills.  Here are a few other things that you may not know about withdrawing from retirement:


Retirement Withdrawals Add to Your Taxable Income

If you are on the cusp of moving into the next tax bracket, you may want to hold off on withdrawing from retirement.  Not only could your retirement dollars be taxable at your regular tax rate, the amount you withdraw could increase the percent of tax you pay. 


For example: May Smith, age 35, who is a single taxpayer has taxable income of $35,000 withdraws $20,000 from her 401(k) plan making her total taxable income $55,000.  Her income tax rate goes from 12% to 22% on all income ($55,000), plus the 10% penalty on the $20,000!  She is now paying $6,400 in taxes/penalties on that distribution.


When Your Taxable Income Goes Up, Premium Tax Credits Have to be Paid Back

If you receive your health insurance from the Marketplace and receive Premium Tax Credits to help pay for that insurance, you may have to pay some or all of the credits back with your return if your income increases.  Although there is no penalty for not having health insurance in 2019, Premium Tax Credits are given to lower income families and individuals to ensure that they can afford coverage.  You are receiving these credits that are planned around a specific amount of income.  With a distribution of retirement, it may send your income over the limit for credits causing major taxes due at the end of the year.


Retirement Withdrawals are a Taxable Event that are Required to be Reported on Your Return

If you take money out of your retirement, in most cases you must file a return. 


Some Retirement Plans Allow You to Borrow Against Your Balance

That’s right!  This can be the most beneficial way to withdraw from your retirement plan.  There are NO tax consequences of borrowing from your retirement because the money is not added to your income.  Also, when you pay back the loan, you are essentially paying yourself back with interest. WIN WIN!!


Retirement Withdrawals Can Make Your Social Security Taxable

Added with your other income, each year there is a threshold amount of income that you can make before your Social Security is up to 85% taxable.  For the 2018 tax year, the limit was $25,000 if you are a single filer, head of household or qualifying widow or widower with a dependent child. The limit for joint filers was $32,000. If you are married filing separately, you automatically have to pay taxes on 85% of your Social Security income.


Essentially, if you normally do not have to file a return because you only make $20,000 in Social Security, but you have withdrawn $45,000 out of retirement to pay off debt, you now have to pay taxes on $62,000 this year. 


It pays to plan ahead.  You have worked hard for your retirement.  Don’t pay the IRS 1 penny more than you have to.  Let the experts at U S Tax Solutions help!


Amy Psyhos is an Enrolled Agent and our Tax Resolution Manager. She personally assists potential and existing clients in having a better understanding of the resolution process. She evaluates each client’s financial information to identify available settlement options to best handle their IRS debt. As information is requested from the IRS, she gathers and prepares all of the necessary documents to ensure all IRS deadlines are met.

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