How Do I Avoid Taxes on my IRA?

by Jeff Reeves | July 23, 2012 6:15 am

How Do I Avoid Taxes on my IRA?

AskTheEditor logo2 300x200 How Do I Avoid Taxes on my IRA?[1]“I have an IRA and have had it for perhaps 2 decades. I would like to cash it out. I have a totally self-directed portfolio so I will be doing this on my own. What are the tax consequences and how do I cash it out?”

First off, the magic number for IRAs is 59.5 years. If you’re older than that, you won’t be hit with an additional 10% tax for early withdrawal. If you’re younger than 59.5, you are better off leaving the money in there unless there is extreme hardship (such as a pending foreclosure) that demands such a move.

There are work-arounds, of course, such as taking a loan against your IRA and then repaying it, but try other options to avoid this 10% penalty.

Like I said, f you are over 59.5, you don’t pay the penalty. That’s the good news. But unfortunately since IRAs deliver tax deferrals on money put in, you have to pay taxes on money you take out. You must include this money on lines 15a and 15b of Form 1040 when you file taxes each year.

As such, it often doesn’t make sense to take your entire nest egg out of the IRA in one fell swoop (what I’m inferring you mean by “cash out”) unless you have ways to mitigate the tax burden.

For instance, if you have a few hundred thousand dollars in there, you could be lumped into the highest tax bracket. I would be judicious about your withdrawals — not just to ration your money for retirement and allow it to continue growing via investments in your IRA, but also to avoid the tax man.

There are also complicated exceptions worth noting, such as if you put non-deductible cash in and therefore paid taxes on the front end. Smart Money has a good article about this here[2] … but as you can see, the math is very convoluted.

I appreciate your ownership of your retirement portfolio and your desire to be self-directed. But if your IRA is complex (such as non-deductible portions of the funds or multiple IRAs or a complicated personal tax burden) then I would strongly advise spending a few hundred dollars on a visit to a qualified CPA or financial advisor who can point you in the right direction.

All retirement accounts are personal, and if you’re concerned about the best decision for you, the right move is to bring all your paperwork to a trustworthy professional who can give you explicit guidance. In the long run, it’s money well spent.

Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.”[3] Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP.

Endnotes:
  1. [Image]: mailto:editor@investorplace.com
  2. a good article about this here: http://www.smartmoney.com/taxes/income/taxes-on-ira-withdrawals/
  3. “The Frugal Investor’s Guide to Finding Great Stocks.”: http://www.amazon.com/dp/B007KB9CSI/ref=rdr_kindle_ext_tmb

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