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Author: Evenstar Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75378  
Subject: Taxes due at withdrawal Date: 9/29/1998 3:16 PM
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I've recently realized that there's something I don't understand about the taxes we'll need to pay on a traditional IRA. My understanding is that we'll pay ordinary income taxes on withdrawals at our tax rate at that time. Does this include taxes on the earnings? Or do we pay capital gains on those? If the latter, do we pay the capital gains rate at the time of the withdrawal or at the time the gain occurred? And who decides what proportion of what we withdraw is contribution and what is earnings?

We've been assuming we could ignore capital gains implications of any trading we do. Is that true?

Evenstar
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Author: vargaj Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5725 of 75378
Subject: Re: Taxes due at withdrawal Date: 9/29/1998 4:31 PM
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The way it works is that you pay ordinary rates in affect at the time of the distribution. There are no capital gains. If 100% of your contributions were deductible then 100% of your distributions are taxable. If Some of your contributions were not deductible then what the IRS says is that you pay taxes in proportion to the amount that was deductible to the total value of the ALL of your IRAs.

Example: Let's suppose you have 2 IRAs each worth $10,000. let's suppose IRA A was originally funded with fully deductible contributions of $4000. Suppose IRA B was originally funded with $2000 of non deductible contributions and $2000 of deductible contributions. there is $6000 gain on both IRA's.

Suppose now you take $5000 out of IRA A.:

The total value of all your IRA's is$20000=x. The non-deductibel part of IRA B is $2000=y

You pay taxes on $5000X(x-y)/x=$5000X0.90=$4500.

In simple terms your IRA's are worth $20,000 and your non deductible contributions are $2000 (10%) so you pay taxes on 90% of your distributions.

In this calculation all IRA's are added together and treated as 1 IRA. it doesn't matter which IRA you actually take the distributions from.

Joe Varga

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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5728 of 75378
Subject: Re: Taxes due at withdrawal Date: 9/29/1998 5:36 PM
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Greetings, Evenstar, and welcome. You asked:

I've recently realized that there's something I don't understand about the taxes we'll need to pay on a traditional IRA. My understanding is that we'll pay ordinary income taxes on withdrawals at our tax rate at that time. Does this include taxes on the earnings? Or do we pay capital gains on those? If the latter, do we pay the capital gains rate at the time of the withdrawal or at the time the gain occurred? And who decides what proportion of what we withdraw is contribution and what is earnings?

We've been assuming we could ignore capital gains implications of any trading we do. Is that true?


Joe Varga gave you a great reply with examples, so there's not much I can add. If you haven't read his reply, you should. Just keep in mind that all earnings and all previously untaxed contributions in a traditional IRA are taxed when withdrawn at the ordinary tax rates in effect at that time. Because of that, there are no capital gains implications in an IRA investment. If you have a mixture of deductible and nondeductible contributions in your IRAs, then part of any withdrawal will avoid taxes and part will be taxed. The computations are as described by Joe. See IRS Publication 590, Individual Retirement Arrangements, for details. You can get that Pub at: http://www.irs.ustreas.gov/prod/forms_pubs/index.html

Regards….Pixy




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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5729 of 75378
Subject: Re: Taxes due at withdrawal Date: 9/29/1998 5:38 PM
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Joe, you wrote in part:

In simple terms your IRA's are worth $20,000 and your non deductible contributions are $2000 (10%) so you pay taxes on 90% of your distributions.

In this calculation all IRA's are added together and treated as 1 IRA. it doesn't matter which IRA you actually take the distributions from.
>

By jove, I think you've got it! :-) Great reply. Thanks.

Regards....Pixy

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Author: Bob78164 Big red star, 1000 posts Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5733 of 75378
Subject: Re: Taxes due at withdrawal Date: 9/29/1998 7:35 PM
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Evenstar writes:

I've recently realized that there's something I don't understand about the taxes we'll need to pay on a traditional IRA. My understanding is that we'll pay ordinary income taxes on withdrawals at our tax rate at that time. Does this include taxes on the earnings? Or do we pay capital gains on those? If the latter, do we pay the capital gains rate at the time of the withdrawal or at the time the gain occurred? And who decides what proportion of what we withdraw is contribution and what is earnings?

We've been assuming we could ignore capital gains implications of any trading we do. Is that true?


I reply:

It's true. All of your IRA earnings will be taxed upon withdrawal as regular income, not capital gains. For this reason, depending on your individual situation, it can make sense to save in a taxable account rather than a tax-deferred IRA.

The IRS decides how much of your withdrawal is contribution and how much is earnings. To be precise, your withdrawals are attributed pro rata between earnings and contribution. --Bob

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