Before you take any money out of a retirement plan, you should consider the potential impact it could have on the amount of income tax you might have to pay.
Some people take an early withdrawal from their IRA or retirement plan. Doing so in many cases triggers an added tax on top of the income tax you may have to pay. Here are some key points you should know about taking an early distribution:
1.Early Withdrawals. An early withdrawal normally means taking the money out of your retirement plan before you reach age 59½.
2.Additional Tax. If you took an early withdrawal from a plan last year, you must report it to the IRS. You may have to pay income tax on the amount you took out. If it was an early withdrawal, you may have to pay an added 10 percent tax.
3.Nontaxable Withdrawals. The added 10 percent tax does not apply to nontaxable withdrawals. They include withdrawals of your cost to participate in the plan. Your cost includes contributions that you paid tax on before you put them into the plan.
A rollover is a type of nontaxable withdrawal. A rollover occurs when you take cash or other assets from one plan and contribute the amount to another plan. You normally have 60 days to complete a rollover to make it tax-free.
4.Check Exceptions. There are many exceptions to the additional 10 percent tax. Some of the rules for retirement plans are different from the rules for IRAs. See IRS.gov for details about these rules.
5.File Form 5329. If you made an early withdrawal last year, you may need to file a form with your federal tax return. See Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts, for details.
According to an article by Kevin McCoy in USA Today, your chances of facing an IRS audit fell to the lowest level in at least a decade in 2014 and are expected to drop further this year, according to updated data from the nation’s tax-collection agency.
The IRS has provided some guidance on what income may or may not be taxable in IRS Tax Tip 2015-4.
All income is taxable unless the law excludes it. Here are some basic rules you should know to help you file an accurate tax return:
- Taxed income. Taxable income includes money you earn, like wages and tips. It also includes bartering, an exchange of property or services. The fair market value of property or services received is taxable.
Some types of income are not taxable except under certain conditions, including:
- Life insurance. Proceeds paid to you because of the death of the insured person are usually not taxable. However, if you redeem a life insurance policy for cash, any amount that you get that is more than the cost of the policy is taxable.
- Qualified scholarship. In most cases, income from this type of scholarship is not taxable. This means that amounts you use for certain costs, such as tuition and required books, are not taxable. On the other hand, amounts you use for room and board are taxable.
- State income tax refund. If you got a state or local income tax refund, the amount may be taxable. You should have received a 2014 Form 1099-G from the agency that made the payment to you. If you didn’t get it by mail, the agency may have provided the form electronically. Contact them to find out how to get the form. Report any taxable refund you got even if you did not receive Form 1099-G.
Here are some types of income that are usually not taxable:
- Gifts and inheritances
- Child support payments
- Welfare benefits
- Damage awards for physical injury or sickness
- Cash rebates from a dealer or manufacturer for an item you buy
- Reimbursements for qualified adoption expenses