14 Apr How do I calculate tax on my retirement withdrawals?

Q. I have two retirement accounts: one was pulled from my paycheck before taxes, so I know that I’ll pay taxes on when I use it. The other I’ve been contributing into for 20 years with money that has already been taxed. When it comes time for the minimum distribution, how are they taxed?
— Taxpayer

A. It seems you’re saying you have a 401(k) that received pre-tax contributions and also an IRS that was funded with after-tax money.

The amount that is going to be taxed will depend on the amount you have and the total amount of after-tax dollars in your IRA.

When you start taking distributions from the account to which you made pre-tax contributions, you will be required to pay ordinary income taxes on the distributions made, said Marnie Hards, a certified financial planner with Aznar Financial Advisors in Morris Plains.

“You will be subject to the Required Minimum Distribution rules that state that a taxpayer must start taking distributions by April 1 of the year following the year you turn 72 for those born after June 30, 1949,” she said. “If you forget to take your RMD, you will be subject to a 50% penalty on the amount that should have been withdrawn, so it is very important to take that distribution each year.”

It sounds like you have also been making contributions to a traditional IRA with after-tax money for 20 years. Since these contributions have already been taxed, when you take distributions from this account, they are considered partially return of after-tax contributions and partially return of growth, Hards said.

Hopefully you have been carefully tracking your annual contributions via Form 8606 so that you have good records of how much of the account is made up of after-tax dollars, she said.

You are not permitted to isolate the after-tax amount when determining your distributions, she said.

“The rule states that you must divide the total of your after-tax amount by the total account balance to calculate a percentage,” she said. “This percentage is applied to your annual distributions to determine what amount is taxable.”

If, for example, your total IRA balance is $200,000 and your after-tax contributions are $20,000, you would divide $20,000 by $200,000 to come up with 10%. This means that 10% of all your distributions for the year will not be taxable, she said.

Note that the money in a 401(k) plan does not count towards this balance. If it is rolled over into an IRA, then it would be included in the above calculation, she said.

So the RMDs for two different types of accounts should be calculated separately, she said.

If you have multiple IRA accounts or 401(k) accounts, you are permitted to withdraw an RMD for an IRA from another IRA — but not an inherited IRA — but a taxpayer is not permitted to take RMDs required for one type of retirement account from another account.

“So, if you leave the money in a 401(k) and have an IRA, you will need to take two distinct RMD’s, one from each account,” Hards said. “If you roll over the 401(k) and combine the balance into one IRA, you can calculate the RMD on the total account balance and the tax implications would be pro-rata.”

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This story was originally published on April 14, 2022.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.