IRA Tax Implications: Understanding Taxation on Retirement Income

Dear Dr. Don,
Are IRA monies retrieved at age 70 or later taxed the same as before 70? Is the tax on an IRA based on income? Will the tax on an IRA go up from what it is now?
— Tom Traditional

Dear Tom,
An IRA account is typically funded with deductible contributions made with pretax dollars, although it is possible to make nondeductible contributions to an IRA account with after-tax dollars. For this reply, I’m going to assume that all contributions to your IRA were deductible contributions.

Because you didn’t pay income tax on the money going into the IRA, the government is going to make you pay income taxes on the distributions out of the account. The tax rate will be based on your income in the year that you take the distribution.

Taking a large distribution in any single year can put you in a higher marginal federal income tax bracket, raising the tax impact of the distribution.

Conventional wisdom has you in a lower tax bracket in retirement than you were in when you were working. That’s not always the case. No one knows for sure where income tax rates will be in the future, but the probability that they’re going lower seems small.

Working with your tax professional to manage your income tax exposure can be an important part of managing your retirement nest egg. Changes in the tax code effective for the 2010 tax year have a lot of IRA account holders considering a Roth IRA conversion. Again, your tax professional is the best person to advise you on the potential benefits of converting.

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