How to Handle Cashing Out an IRA After 60
Accessing IRA funds after 60 is penalty-free but requires careful tax planning. Understand how withdrawals are treated to help manage your income in retirement.
Cashing out an Individual Retirement Arrangement (IRA) involves taking a distribution from the account. For individuals over age 60, this action is free from the 10% early withdrawal penalty that applies to younger accountholders. However, the absence of a penalty does not mean the withdrawal is free from tax consequences. The tax treatment of the withdrawn funds depends heavily on the type of IRA you own.
Taxation on Traditional IRA Withdrawals
Distributions from a Traditional IRA are subject to federal and state income tax. This is because contributions are often made with pre-tax dollars, meaning you received a tax deduction when the contribution was made, and the investments have grown tax-deferred. When you withdraw money after age 59.5, both your original contributions and any investment earnings are taxed as ordinary income. This withdrawn amount is added to your other income sources, such as Social Security, which can push you into a higher tax bracket.
For example, if you are in the 22% federal tax bracket and withdraw $50,000, that entire amount is added to your taxable income for the year. This results in a federal tax liability of $11,000 on that distribution, not including any applicable state taxes.
A different rule applies if you have made non-deductible contributions to your Traditional IRA. These are contributions made with after-tax dollars for which you did not claim a tax deduction. The portion of your withdrawal that represents these non-deductible contributions is not taxed and is referred to as your “basis.”
To properly account for your basis, you must file IRS Form 8606, Nondeductible IRAs. This form tracks your non-deductible contributions and is used to calculate the pro-rata share of a distribution that is tax-free. Failing to file this form can result in paying tax on the same money twice.
Taxation on Roth IRA Withdrawals
Withdrawals from a Roth IRA can be entirely tax-free if they are considered a “qualified distribution.” For individuals over age 60, a qualified distribution must meet one condition: the Roth IRA must have been open for at least five years. This five-year holding period begins on January 1 of the tax year for which the first contribution was made. The five-year clock starts with your very first contribution to any Roth IRA, not for each subsequent contribution. If this rule is met, all withdrawals, including both contributions and earnings, are received without federal income tax liability.
If you take a distribution from a Roth IRA before the five-year rule has been met, the tax treatment follows a specific order. Your own contributions are returned first and are completely tax- and penalty-free. After all of your contributions have been withdrawn, any subsequent amounts are considered investment earnings. These earnings would be subject to ordinary income tax, but not the 10% early withdrawal penalty since you are over age 59.5.
Navigating Required Minimum Distributions
Required Minimum Distributions (RMDs) are minimum amounts that owners of certain retirement accounts must withdraw annually. The purpose of RMDs is to ensure that tax-deferred funds are eventually paid out and taxed. The SECURE 2.0 Act raised the age for beginning RMDs to 73 for individuals who reach age 72 after December 31, 2022. The age will increase again to 75 for those who reach age 73 after December 31, 2032.
RMDs apply to Traditional IRAs, SEP IRAs, and SIMPLE IRAs. A significant feature of Roth IRAs is that the original owner is not required to take RMDs during their lifetime, allowing the funds to continue growing tax-free.
The RMD amount is calculated each year based on the IRA’s fair market value on December 31 of the preceding year and the owner’s life expectancy factor from the IRS’s Uniform Lifetime Table. The penalty for failing to take the full RMD amount is an excise tax of 25% on the portion not withdrawn. This penalty can be reduced to 10% if the shortfall is corrected in a timely manner.
How to Initiate a Withdrawal
To begin the process of taking money from your IRA, the first step is to contact the financial institution, known as the custodian, that holds your account. This could be a bank, brokerage firm, or mutual fund company. The custodian will provide you with the necessary paperwork and guide you through their specific procedures.
You will need to complete a distribution request form, which can often be done online or on paper. This form will ask for your personal details, the IRA account number, and the amount you wish to withdraw. A decision on this form is whether to have federal and state income taxes withheld directly from the distribution, which can be specified using Form W-4P.
Once the paperwork is submitted, the funds can be disbursed to you. Common methods include an electronic funds transfer (EFT) directly into your bank account or a physical check mailed to your address.
Following the withdrawal, the custodian will send you and the IRS a copy of Form 1099-R in January of the following year. This form reports the gross amount of your distribution and how much of it is considered taxable income. You will use the information on Form 1099-R to report the withdrawal on your annual income tax return.