Why am I double taxed on my retirement money?
Question by DRAGGON: Why am I double taxed on my retirement money?
If, I withdraw my retirement money early I am charged a certain percent to withdraw it. Then, I am taxed again when I have to claim the money on my end of year taxes, 1040 form.
Best answer:
Answer by acermill
You are not being double taxed. The first charge is the penalty for early withdrawal. You are taxed at the end of the year because the money was put away in your retirement plan BEFORE tax was paid on it.
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Well the tax to withdraw money from a retirement account is meant as a disincentive to withdraw that money in the first place. I mean, what’s the point of withdrawing money meant to be used for your future retirement? They do make exceptions where that penalty doesn’t apply (1st time housebuying, education, death, & disability).
As for end of year taxes, if you’re contributing to a Roth IRA, you’re taxed now on what you contribute (the contribution doesn’t reduce your taxable income thus your taxes are higher because your taxable income is higher) but when you retire & receive the funds, they are non-taxable. If contributing to a traditional IRA, you get to claim the tax benefit of it now but when you retire & receive funds, you pay the taxes on it at that point. The advantage with the Roth is that although you get no tax benefit, you’re getting taxed on the contribution but the contribution you make grows over time and is worth more when you retire & its all tax-free.
Most retirement plans allow you to put money into the plan that has NOT been taxed. Either this money is subtracted from your W-2 income (employee sponsered retirement plans) or you can take a deduction on your tax return (traditional IRA – note this deduction may be phased out at higher income levels).
When you take this money out of the retirment plan, you are taxed on it at that time. It has not been double taxed as you did not pay tax on it when the money was originally earned.
You will be charged a penalty to withdraw these funds early. The penalty is imposed to prevent abuse of the system. There are a number of exceptions to this penalty (first time homebuyer, education expenses).
I frigging despise the IRS, but their reasoning is that you were allowed to defer taxes on that money as long as it remained in a tax sheltered account. If you take it out anytime before that, then you have to pay them an extra 10% to make up for them not being able to get their alotment of your wages earlier.
It goes under the “time value of money” principal, best known by the phrase “a dollar today is worth more than a dollar tommorrow”. It also helps people make the distinction between a true tax deferred account and a standard bank account. Unfortunately most people don’t take the time to learn the distinction and that gives those fat pig fornicators a second shot at your cash.
It is awesome that you are starting to save money though. Remember the key is to let it build up over time and the more money that is in there means the earning power your account will have later in your career. The people that get started early in life have a significant advantage becuase of this. Starting early combined with responsible management (not taking loans or withdrawals, contributing as much as you can while still maintaning a lifestyle that does not have you drowning in debt) will often become a leaping to early retirement.
I
What’s withheld is just like the withholding from your paycheck. When you fill out your tax form, you calculate your total tax, then that’s compared to what was withheld – if you had too much withheld, you get the extra refunded, and if you didn’t have enough withheld, you have to pay the amount you’re short. You’re not being double taxed in either case. The amount that’s withheld at the time you withdraw the money is applied to the tax you owe when you file your return.
You pay income tax at whatever your rate is on the amount you withdraw, plus a 10% penalty if you take it out before you’re 59-1/2.
You didn’t specify what your investment vehicle is, but I see things a bit differently.
You mentioned that you are being charged a “percentage,” when you withdraw your money, early. Yes, that could very well be tax withholding, for which you will receive credit, when you file your tax return, but I am wondering if your investment vehicle is an annuity, where you are paying the insurance company a “Contingent Deferred Sales Charge (CDSC)” for a withdrawal of more than 10% of your accumulated balance. That CDSC is not a tax, at all, but a sales charge, or commission.
Then, come tax filing time, yes, you owe income tax, at ordinary income tax rates, multiplied to the amount of your withdrawal.
The scenario is similar if your investment vehicle is Class B mutual funds, where a deferred sales charge, for early withdrawal, applies.
In any case, and similar to the other answers, since you will receive credit for tax withheld, you are not being double-taxed.
Phil
http://www.phillipfostercpa.com/money.html
That’s not double taxation. When you take an early withdrawal it is subject to 20% withholding. You then have to settle up with the IRS when you file your tax return. Since the 20% withholding is not enough to cover the total liability for most taxpayers, you will have to pay at tax time.
Simply stated, you are not being double taxed on your money regardless of how you invest it.
Read below for brief explanations:
Traditional IRA’s and 401(k). Your taxable income is reduced when you make contributions. When you withdraw the money, then tax is collected as ordinary income.
Roth IRA’s and Roth 401(k)’s. You don’t get a deduction when you make contributions. When you withdraw the money, there is no tax collected.
Any other investment. You don’t get a deduction when you make the investment. When you withdraw the money, only the earnings (interest and realized capital gains) are taxed. The earnings are money that you never had before.
Hope this helps explain things.
When you withdraw your money, some of it is withheld and sent in for income taxes. Then, when you file your taxes, if the amount withheld is not enough to pay the taxes you owe, you will owe additional tax. If the amount withheld is more than the tax, you will a refund of the difference.
So you are not taxed twice, you just might be paying it in two payments.