Taxes & Withdrawal From Retirement Accounts

Planning for retirement is rarely a simple task. For one thing, a resident must carefully ask the basic question: How much do I need? Sophisticated models and projections exists to help make educated guesses about this answer. But it is never an exact science. That is because it is impossible to say with certainty how long the retirement will last or what the future financial world will look like.

On top of that, however, there is also significant complexity regarding the accounts, trusts, and other tools used to provide the assets and income needed in retirement. It is critical to understand tax issues with retirement accounts and investments to appreciate exactly how much money will be available for you to live in your golden years.

Take, for example, the issue of taxes and individual retirement accounts (or any other tax-deferred plan). Do you know how much of the account will be taxed on withdrawal?

A Wall Street Journal story this week explored how many investors are not familiar with the specific tax rules related to IRAs. Most appreciate that the federal government will take a tax bite out of those withdrawals (no taxes were paid when initially put into the account). But will states take out an income tax as well?

The answer: it depends. Each state has somewhat different rules. Those living in the seven states that have no income tax obviously will not have a state tax burden. But even those in states with a state income tax, like New York, may have some special rules apply which minimize the tax.

As in most states, in New York, a resident is able to deduct their IRA contributions when they are actually made. This means that the tax is applied years later, when the money is withdrawn. However, under New York law, the first $20,000 of retirement plan withdrawals are actually exempt (at least for those over 59.5 years old). In other words, the state tax bite on the retirement withdrawal may be a bit less than expected.

An added complexity comes if one move to a different state. Which state’s law applies: the one where you set up the account or where you live when you withdraw from it? In most cases, the latter is true, the rules of your current state apply. Therefore those who move into or out of the state need to investigate the area’s particular tax rules to understand exactly what their obligation will be on what funds will actually make it to their bank account.

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