IRA Withdrawal Tax Considerations for 2025

"When do you pay taxes on IRA withdrawals?" is an important question for taxpayers when planning their long-term financial stability and prosperity. This is because savers can withdraw money from their IRAs at any point, but not without potential penalties.

An IRA is a fundamental part of most retirement plans. Knowing how to get the most out of your retirement savings is therefore a must for comfortable, stable, and affluent post-work years.

When Are IRAs Taxed?

How and when your IRA is taxed depends on whether it's a traditional IRA or a Roth IRA.

Traditional IRA Withdrawals

Funds in a traditional IRA—including contributions and earnings—aren't taxed until after you take a withdrawal. In most cases, this means after the account holder reaches age 59 ½. At this point, withdrawals are considered part of your gross income and are taxed as ordinary income. However, making withdrawals before the age of 59 ½ will incur a 10% penalty on top of ordinary income tax. 

Taxpayers make tax-free traditional IRA contributions during their working life. This means you contribute to your IRA from your pre-tax income and these contributions will reduce your taxable income in the year they are made. However, it also means you'll pay federal income tax on the funds you withdraw during your retirement.

Depending on where you live, you may also pay state-level taxes on your withdrawals. However, residents in the Sunshine State won't pay state-level Florida retirement income tax. This is true whether you've always lived and worked in Florida or accumulated your retirement savings in another state.

Always consult professionals in tax planning services before making a significant withdrawal from your IRA. Our experts in Jacksonville, Florida, and Spartanburg, South Carolina can advise you on the implications of withdrawing from your account and suggest ways to optimize your tax bill. A large part of planning for a comfortable retirement is taking the right steps at the right time, and tax planning experts help with this.

Roth IRA Withdrawals

Roth IRA withdrawals aren't taxed during retirement because taxpayers contribute to their Roth IRA with after-tax dollars. This means you can withdraw money from your Roth IRA throughout your retirement without worrying about taxes.

One of the advantages of a Roth IRA over a traditional IRA is that you can withdraw your contributions even before retirement without paying taxes or penalties. However, earnings from your Roth IRA are subject to more stringent regulations. Withdrawing earnings from your Roth IRA that aren’t classed as qualified distributions will incur a 10% penalty plus income tax. 

Roth IRA Taxes on Earnings

It's important to establish the difference between Roth IRA contributions and earnings. Remember, you can withdraw Roth IRA contributions at any time without taxes or penalties. However, the earnings from your Roth IRA are a different story.

Your IRA funds will grow tax-free in your Roth IRA. What you earn from interest from your IRA are your earnings. Taxpayers must abide by the regulations surrounding cashing out IRA earnings or face a penalty. Withdrawing Roth IRA earnings tax-free depends on them being a "qualifying distribution." This is a withdrawal made:

• 5 years or more after the first contribution to your Roth account; and

• After the age of 59 ½ 

Qualified distributions also cover withdrawals made because the account holder is disabled or when distributions are made to a beneficiary after your death. Remember, withdrawing investment earnings before this time will incur a 10% early withdrawal penalty on what you withdraw plus your ordinary income tax rate.

When Are Self-Directed IRAs Taxed?

When Self-Directed IRAs (SDIRAs) are taxed depends on if you set up your SDIRA as a traditional or Roth IRA. In the same way as a traditional IRA, withdrawals made from an SDIRA before the age of 59 ½ will generally be subject to income tax and a penalty.

Exceptions to Tax on Early Distributions

The IRS offers certain exceptions to tax on early distributions. This means you can make withdrawals from your IRA without facing the 10% early withdrawal tax in circumstances including the following:

• Disability: Total and permanent disability of the IRA owner

• Disaster recovery distribution: Qualifying individuals who sustain an economic loss due to a federally declared disaster can withdraw up to $22,000 without penalty.

• Education: Qualified higher education expenses

• First home purchases: First-time home buyers can withdraw up to $10,000 penalty-free.

• Some medical expenses: Eligible medical expenses include health insurance premiums paid while unemployed or unreimbursed medical expenses that are more than 7.5% of your adjusted gross income (AGI).

Always check with a tax professional before making early withdrawals from your IRA. The regulations surrounding tax matters are often complex and it's easy to make costly mistakes without expert guidance.

Key Changes to IRA Withdrawals for 2025

In 2025, there are two main changes that impact both savers and their beneficiaries. Be aware of these changes and how they will impact your tax bill:

The 10-Year Rule

The 10-Year Rule stipulates that heirs who inherited an IRA after 2020 must empty the account within 10 years of the owner’s passing. This rule applies if the original owner reached the RMD age before their death. The exceptions to this rule are a surviving spouse, minors, a disabled or chronically ill person, or those less than 10 years younger than the IRA account owner. 

This change may increase the tax burden on the inheritors as it could move them into a higher tax bracket or trigger other taxes like the new investment income tax. Previous to this rule, beneficiaries could make strategic withdrawals over a greater number of years to minimize their tax burden. 

Taxpayers with significant assets in their IRA are advised to seek professional advice to reduce the tax burden on their heirs. For example, it may be tax-favorable to leave funds in one or more tax-deferred retirement plans.

Lower Penalty for Missing an RMD

In better news for IRA owners, the penalties for missing an RMD have been lowered from 50% to 25%. The penalty is further reduced to 10% if the mistake is rectified within two years. However, it remains important to track distribution schemes, especially for retirees with more than one account.

How to Minimize Taxes on IRA Withdrawals

An expert in tax planning will help you plan your IRA withdrawals in the most tax-favorable way. Ask how the following strategies could help minimize the tax you pay on your retirement account:

• Roth IRA conversion: Consider converting the funds in your traditional IRA into a Roth IRA. You'll pay taxes on the amount you convert in the same year it is converted. However, subsequent withdrawals (including contributions and earnings) from the Roth IRA are tax-free. This strategy is particularly interesting if you expect to be in a higher tax bracket in the future or you anticipate future tax rises.

• Prioritize Roth contributions: Prioritize contributions to your Roth IRA if you have one. Qualified withdrawals of contributions and earnings are tax-free. This means it will provide tax-free income during your retirement.

• Delay withdrawals from your IRAs: Delay withdrawals until you're in a lower tax bracket. For most, this will mean during retirement when you likely have fewer income sources. This will reduce the amount of tax you owe on your withdrawals. 

One of the potential downsides to a traditional IRA is the required minimum distributions. These kick in at age 73 ½. Though most retirees will be keen to use their IRA retirement savings, the RMDs may push some into a higher tax category. Ask an expert about the implications of these RMDs.

Tax Implications of Traditional IRA vs Roth IRA Compared

The following table outlines the main differences between traditional and Roth IRAs from a tax perspective. However, it’s always recommended to get professional advice when making significant financial decisions.

Feature	Traditional IRA	Roth IRA
Contributions	Tax-deductible in the year of contribution	After-tax contributions
Growth	Tax-deferred	Tax-deferred
Withdrawals	Taxable as ordinary income	Tax-free if qualified
Early Withdrawal Penalty?	Yes, 10% penalty + ordinary income tax rate	10% penalty + ordinary income tax rate for withdrawals on earnings. No penalty for withdrawing contributions.
Required Minimum Distributions (RMDs)?	Yes, starting at age 73 ½	No
Estate Planning	Can be passed on to beneficiaries, subject to income tax	Can be passed on to beneficiaries tax-free

Other IRA Tax Considerations

Ask your tax professional about the following considerations when planning your IRA strategy going forward:

Account Rollovers

If you and your employer have been paying into a 401(k) but you change jobs, you can consider converting your funds into a Roth IRA. However, you will have to pay federal income tax on the full amount you move at the time of the rollover. 

Other alternatives include keeping your assets where they are, rolling them over into your new employer’s 401(k) plan, transferring the funds to a traditional IRA, or even taking a cash distribution. 

Roth 401(k)

Some employers offer a Roth 401(k) as well as a traditional 401(k). This gives you the option to direct some (or all) of your paycheck into a post-tax Roth 401(k) and some pre-tax dollars into a regular 401(k).

Optimize Your Retirement Savings

Understanding the tax implications of IRA withdrawals is crucial for maximizing your retirement savings. Considering the differences between traditional and Roth IRAs and the implications of making withdrawals means you can make informed decisions that align with your financial goals.

It's essential to consult with a tax professional to assess your specific situation and develop a tax-efficient withdrawal strategy. Plan ahead and make strategic withdrawals to optimize your retirement income and minimize your tax liability.