Are Traditional Ira Distributions Taxed As Ordinary Income? The answer is generally yes, as distributions from a traditional IRA are indeed taxed as ordinary income in the year they are received, explains income-partners.net. However, the specifics can be a bit more intricate, especially when nondeductible contributions are involved, and understanding these nuances can be vital for effective tax planning and increasing your income through strategic partnerships. Let’s delve into the details, exploring various scenarios and insights to illuminate this topic.
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1. What Are Traditional IRAs?
Traditional IRAs, or Individual Retirement Accounts, are retirement savings plans that offer tax advantages. In this publication, the original IRA (sometimes called an ordinary or regular IRA) is referred to as a “traditional IRA.” A traditional IRA is any IRA that isn’t a Roth IRA or a SIMPLE IRA. Contributions to a traditional IRA may be tax-deductible, depending on your income and whether you’re covered by a retirement plan at work. However, distributions in retirement are generally taxed as ordinary income.
1.1. Key Features of Traditional IRAs
Traditional IRAs have two primary tax benefits:
- Tax-deductible contributions: Contributions may be fully or partially deductible in the year they are made, lowering your taxable income.
- Tax-deferred growth: Earnings and gains within the IRA aren’t taxed until they are distributed, allowing your savings to grow faster.
1.2. Are There Different Types of IRAs?
Yes, the main types of IRAs include traditional IRAs, Roth IRAs, SEP IRAs, and SIMPLE IRAs. Each type has different rules regarding contributions, deductions, and distributions. This publication primarily covers traditional IRAs.
2. How Are Distributions Taxed?
Distributions from traditional IRAs are generally taxed as ordinary income in the year you receive them. This means that the money you withdraw is taxed at your current income tax rate, just like your salary or wages.
2.1. Ordinary Income Taxation
Distributions from traditional IRAs that you include in income are taxed as ordinary income.
2.2. No Special Treatment
In figuring your tax, you can’t use the 10-year tax option or capital gain treatment that applies to lump-sum distributions from qualified retirement plans.
2.3. Exceptions to Taxable Distributions
There are a few exceptions to the rule that distributions from traditional IRAs are taxable. These include:
- Rollovers: When you move funds from one IRA to another, or from a qualified retirement plan to an IRA, the transfer isn’t taxed as long as it’s completed within 60 days.
- Qualified charitable distributions (QCDs): If you’re age 70½ or older, you can donate up to $105,000 per year from your IRA directly to a qualified charity, and the distribution isn’t taxed.
2.4. What Are Qualified Charitable Distributions (QCDs)?
A qualified charitable distribution (QCD) is generally a nontaxable distribution made directly by the trustee of your IRA (other than an ongoing SEP or SIMPLE IRA) to an organization eligible to receive tax-deductible contributions. You must be at least age 70½ when the distribution was made. Also, you must have the same type of acknowledgment of your contribution that you would need to claim a deduction for a charitable contribution.
2.5. Are There More Exceptions to Distributions from Traditional IRAs Being Taxable?
Exceptions to distributions from traditional IRAs being taxable in the year you receive them are:
- Rollovers
- Qualified charitable distributions
- Tax-free withdrawals of contributions
- The return of nondeductible contributions
2.6. Importance of Understanding Taxation
Understanding how traditional IRA distributions are taxed is essential for retirement planning. By knowing the tax implications, you can better manage your withdrawals and minimize your tax liability. This knowledge also helps in making informed decisions about whether to invest in a traditional IRA or a Roth IRA, which has different tax rules.
3. Nondeductible Contributions and Basis
If you made nondeductible contributions to your traditional IRA, a portion of your distributions will be tax-free. This is because you’ve already paid taxes on the money you contributed. The IRS allows you to recover your basis (the total amount of your nondeductible contributions) tax-free.
3.1. Cost Basis
If you made nondeductible contributions or rolled over any after-tax amounts to any of your traditional IRAs, you have a cost basis (investment in the contract) equal to the amount of those contributions. These nondeductible contributions aren’t taxed when they are distributed to you. They are a return of your investment in your IRA.
3.2. Calculating the Tax-Free Portion
To figure out the tax-free portion of your distributions, you need to use Form 8606, Nondeductible IRAs. This form helps you calculate the taxable and nontaxable portions of your IRA distributions based on your basis in the IRA.
3.2.1. Form 8606
You must complete Form 8606, and attach it to your return, if you receive a distribution from a traditional IRA and have ever made nondeductible contributions or rolled over after-tax amounts to any of your traditional IRAs. Using the form, you will figure the nontaxable distributions for 2024, and your total IRA basis for 2024 and earlier years.
3.3. Reporting Your Nontaxable Distribution on Form 8606
To report your nontaxable distribution and to figure the remaining basis in your traditional IRA after distributions, you must complete Worksheet 1-1 before completing Form 8606. Then, follow these steps to complete Form 8606.
- Use Worksheet 1-2 in chapter 1 of Pub. 590-A, or the IRA Deduction Worksheet in the Form 1040 or 1040-NR instructions to figure your deductible contributions to traditional IRAs to report on Schedule 1 (Form 1040), line 20.
- After you complete Worksheet 1-2 in chapter 1 of Pub. 590-A or the IRA Deduction Worksheet in the form instructions, enter your nondeductible contributions to traditional IRAs on line 1 of Form 8606.
- Complete lines 2 through 5 of Form 8606.
- If line 5 of Form 8606 is less than line 8 of Worksheet 1-1, complete lines 6 through 15c of Form 8606 and stop here.
- If line 5 of Form 8606 is equal to or greater than line 8 of Worksheet 1-1, follow instructions 6 and 7 next. Don’t complete lines 6 through 12 of Form 8606.
- Enter the amount from line 8 of Worksheet 1-1 on lines 13 and 17 of Form 8606.
- Complete line 14 of Form 8606.
- Enter the amount from line 9 of Worksheet 1-1 (or, if you entered an amount on line 11, the amount from that line) on line 15a of Form 8606.
3.4. Worksheet 1-1. Figuring the Taxable Part of Your IRA Distribution
| > Use only if you made contributions to a traditional IRA for 2024 that may not be fully deductible and have to figure the taxable part of your 2024 distributions to determine your modified AGI. See Limit if Covered by Employer Plan in chapter 1 of Pub. 590-A. > Form 8606 and the related instructions will be needed when using this worksheet. > Note. When used in this worksheet, the term “outstanding rollover” refers to an amount distributed from a traditional IRA as part of a rollover that, as of December 31, 2024, hadn’t yet been reinvested in another traditional IRA, but was still eligible to be rolled over tax free. |
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| 1. | Enter the basis in your traditional IRAs as of December 31, 2023 | 1. | _____ |
|---|---|---|---|
| 2. | Enter the total of all contributions made to your traditional IRAs during 2024 and all contributions made during 2025 that were for 2024, whether or not deductible. Don’t include rollover contributions properly rolled over into IRAs. Also, don’t include certain returned contributions described in the instructions for line 7 of Form 8606 | 2. | |
| 3. | Add lines 1 and 2 | 3. | _____ |
| 4. | Enter the value of all your traditional IRAs as of December 31, 2024 (include any outstanding rollovers from traditional IRAs to other traditional IRAs). Subtract any repayments of qualified disaster distributions | 4. | |
| 5. | Enter the total distributions from traditional IRAs (including amounts converted to Roth IRAs that will be shown on line 16 of Form 8606) received in 2024. Also, include repayments of qualified disaster distributions, qualified charitable distributions (QCDs), and a one-time distribution to fund a health savings account (HSA). (Don’t include outstanding rollovers included on line 4 or any rollovers between traditional IRAs completed by December 31, 2024. Also, don’t include certain returned contributions described in the instructions for line 7 of Form 8606.) | 5. | _____ |
| 6. | Add lines 4 and 5 | 6. | _____ |
| 7. | Divide line 3 by line 6. Enter the result as a decimal (rounded to at least three places). If the result is 1.000 or more, enter 1.000 | 7. | _____ |
| 8. | Nontaxable portion of the distribution. Multiply line 5 by line 7. Enter the result here and on lines 13 and 17 of Form 8606 | 8. | _____ |
| 9. | Taxable portion of the distribution (before adjustment for conversions). Subtract line 8 from line 5. Enter the result here, and if there are no amounts converted to Roth IRAs, stop here and enter the result on line 15a of Form 8606 | 9. | _____ |
| 10. | Enter the amount included on line 9 that is allocable to amounts converted to Roth IRAs by December 31, 2024. (See Note at the end of this worksheet.) Enter here and on line 18 of Form 8606 | 10. | _____ |
| 11. | Taxable portion of the distribution (after adjustments for conversions). Subtract line 10 from line 9. Enter the result here and on line 15a of Form 8606 | 11. | _____ |
| Note. If the amount on line 5 of this worksheet includes an amount converted to a Roth IRA by December 31, 2024, you must determine the percentage of the distribution allocable to the conversion. To figure the percentage, divide the amount converted (from line 16 of Form 8606) by the total distributions shown on line 5. To figure the amounts to include on line 10 of this worksheet and on line 18 of Form 8606, multiply line 9 of the worksheet by the percentage you figured. |
3.5. Detailed Illustration of Nontaxable and Taxable Portions
Rose Green has made the following contributions to her traditional IRAs.
| Year | Deductible | Nondeductible |
|---|---|---|
| 2017 | 2,000 | -0- |
| 2018 | 2,000 | -0- |
| 2019 | 2,000 | -0- |
| 2020 | 1,000 | -0- |
| 2021 | 1,000 | -0- |
| 2022 | 1,000 | -0- |
| 2023 | 700 | 300 |
| Totals | $9,700 | $300 |
Rose needs to complete Worksheet 1-1 to determine if her IRA deduction for 2024 will be reduced or eliminated. In 2024, she makes a $2,000 contribution that may be partly nondeductible. She also receives a distribution of $5,000 for conversion to a Roth IRA. She completed the conversion before December 31, 2024, and didn’t recharacterize any contributions. At the end of 2024, the fair market values of her accounts, including earnings, total $20,000. She didn’t receive any tax-free distributions in earlier years. The amount she includes in income for 2024 is figured on Worksheet 1-1.
3.6. Worksheet 1-1. Figuring the Taxable Part of Your IRA Distribution—Illustrated
| > Use only if you made contributions to a traditional IRA for 2024 that may not be fully deductible and have to figure the taxable part of your 2024 distributions to determine your modified AGI. See Limit if Covered by Employer Plan in chapter 1 of Pub. 590-A. > Form 8606 and the related instructions will be needed when using this worksheet. > Note. When used in this worksheet, the term “outstanding rollover” refers to an amount distributed from a traditional IRA as part of a rollover that, as of December 31, 2024 hadn’t yet been reinvested in another traditional IRA, but was still eligible to be rolled over tax free. |
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| 1. | Enter the basis in your traditional IRAs as of December 31, 2023 | 1. | 300 |
|---|---|---|---|
| 2. | Enter the total of all contributions made to your traditional IRAs during 2024 and all contributions made during 2025 that were for 2024, whether or not deductible. Don’t include rollover contributions properly rolled over into IRAs. Also, don’t include certain returned contributions described in the instructions for line 7 of Form 8606 | 2. | 2,000 |
| 3. | Add lines 1 and 2 | 3. | 2,300 |
| 4. | Enter the value of all your traditional IRAs as of December 31, 2024 (include any outstanding rollovers from traditional IRAs to other traditional IRAs). Subtract any repayments of qualified disaster distributions | 4. | 20,000 |
| 5. | Enter the total distributions from traditional IRAs (including amounts converted to Roth IRAs that will be shown on line 16 of Form 8606) received in 2024. Also, include repayments of qualified disaster distributions, qualified charitable distributions (QCDs), and a one-time distribution to fund a health savings account (HSA). (Don’t include outstanding rollovers included on line 4 or any rollovers between traditional IRAs completed by December 31, 2024. Also, don’t include certain returned contributions described in the instructions for line 7 of Form 8606.) | 5. | 5,000 |
| 6. | Add lines 4 and 5 | 6. | 25,000 |
| 7. | Divide line 3 by line 6. Enter the result as a decimal (rounded to at least three places). If the result is 1.000 or more, enter 1.000 | 7. | 0.092 |
| 8. | Nontaxable portion of the distribution. Multiply line 5 by line 7. Enter the result here and on lines 13 and 17 of Form 8606 | 8. | 460 |
| 9. | Taxable portion of the distribution (before adjustment for conversions). Subtract line 8 from line 5. Enter the result here, and if there are no amounts converted to Roth IRAs, stop here and enter the result on line 15a of Form 8606 | 9. | 4,540 |
| 10. | Enter the amount included on line 9 that is allocable to amounts converted to Roth IRAs by December 31, 2024. (See Note at the end of this worksheet.) Enter here and on line 18 of Form 8606 | 10. | 4,540 |
| 11. | Taxable portion of the distribution (after adjustments for conversions). Subtract line 10 from line 9. Enter the result here and on line 15a of Form 8606 | 11. | -0- |
| Note. If the amount on line 5 of this worksheet includes an amount converted to a Roth IRA by December 31, 2024, you must determine the percentage of the distribution allocable to the conversion. To figure the percentage, divide the amount converted (from line 16 of Form 8606) by the total distributions shown on line 5. To figure the amounts to include on line 10 of this worksheet and on line 18 of Form 8606, multiply line 9 of the worksheet by the percentage you figured. |
The illustrated Form 8606 for Rose shows the information required when you need to use Worksheet 1-1 to figure your nontaxable distribution. Assume that the $500 entered on Form 8606, line 1, is the amount Rose figured using instructions 1 and 2 given earlier under Reporting your nontaxable distribution on Form 8606.
3.7. Proper Record Keeping
Maintaining accurate records of your IRA contributions, especially nondeductible ones, is vital. Keep copies of Form 5498 (IRA Contribution Information) and Form 8606 to substantiate your basis in the IRA. Without these records, you may be unable to claim the tax-free portion of your distributions.
4. Early Distributions and Penalties
While traditional IRA distributions are generally taxed as ordinary income, withdrawing funds before age 59½ can trigger an additional 10% tax penalty, a measure designed to discourage early withdrawals from retirement accounts.
4.1. Early Distributions Defined
Early distributions are generally amounts distributed from your traditional IRA account or annuity before you are age 59½, or amounts you receive when you cash in retirement bonds before you are age 59½.
4.2. Exceptions to the 10% Penalty
There are several exceptions to the early withdrawal penalty. If one of these exceptions applies, you can withdraw funds from your IRA before age 59½ without incurring the 10% penalty. These exceptions include:
- Unreimbursed medical expenses: Distributions up to the amount of your unreimbursed medical expenses exceeding 7.5% of your adjusted gross income (AGI) are exempt.
- Medical insurance: If you’re unemployed, distributions used to pay for medical insurance premiums may be exempt.
- Disability: If you become disabled, distributions taken due to your disability are exempt.
- Beneficiary: If you inherit an IRA, distributions you take as a beneficiary are exempt.
- Qualified higher education expenses: Distributions used to pay for qualified higher education expenses for yourself, your spouse, or your dependents are exempt.
- First-time home purchase: You can withdraw up to $10,000 for a first-time home purchase without penalty.
- Qualified reservist distributions: Certain distributions to qualified reservists called to active duty are exempt.
- Qualified birth or adoption distributions: Distributions made within one year of the birth or adoption of a child, up to $5,000, are exempt.
.If you were affected by a qualified disaster, see chapter 3.
If you were affected by a qualified disaster, see chapter 3.
***.
4.3. Reporting the Penalty on Form 5329
If you don’t meet any of the exceptions and you take an early distribution, you’ll need to report the 10% penalty on Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts.
4.4. Age 59½ Rule
Generally, if you are under age 59½, you must pay a 10% additional tax on the distribution of any assets (money or other property) from your traditional IRA. Distributions before you are age 59½ are called “early distributions.”
4.5. Exceptions
There are several exceptions to the age 59½ rule. Even if you receive a distribution before you are age 59½, you may not have to pay the 10% additional tax if you are in one of the following situations.
- You have unreimbursed medical expenses that are more than 7.5% of your AGI.
- The distribution is for the cost of your medical insurance due to a period of unemployment.
- You are totally and permanently disabled.
- You have been certified as having a terminal illness.
- You are the beneficiary of a deceased IRA owner.
- You are receiving distributions in the form of a series of substantially equal periodic payments.
- The distribution is for your qualified higher education expenses.
- You use the distributions to buy, build, or rebuild a first home.
- The distribution is due to an IRS levy of the IRA or retirement plan.
- The distribution is a qualified reservist distribution.
- The distribution is a qualified birth or adoption distribution.
- The distribution is a qualified disaster distribution or qualified disaster recovery distribution.
- The distribution is a corrective distribution.
- The distribution is to a domestic abuse victim.
- The distribution is for certain emergency personal expenses.
4.6. Reviewing Early Distribution Penalties
Review the scenarios in which you may have to use Form 5329 to report the tax on excess contributions, early distributions, and excess accumulations:
4.6.1. Filing a Tax Return
If you must file an individual income tax return, complete Form 5329 and attach it to your Form 1040, 1040-SR, or 1040-NR. Enter the total additional taxes due on Schedule 2 (Form 1040), line 8.
4.6.2. Not Filing a Tax Return
If you don’t have to file a return, but do have to pay one of the additional taxes mentioned earlier, file the completed Form 5329 with the IRS at the time and place you would have filed Form 1040, 1040-SR, or 1040-NR. Be sure to include your address on page 1 and your signature and date on page 2. Enclose, but don’t attach, a check or money order made payable to “United States Treasury” for the tax you owe, as shown on Form 5329. Write your social security number and “2024 Form 5329” on your check or money order.
4.7. Key to Minimizing the Additional Tax on Early Distributions
You don’t have to use Form 5329 if any of the following situations exists.
- Distribution code 1 (early distribution) is correctly shown in box 7 of Form 1099-R. If you don’t owe any other additional tax on a distribution, multiply the taxable part of the early distribution by 10% and enter the result on Schedule 2 (Form 1040), line 8. Enter “No” to the left of the line to indicate that you don’t have to file Form 5329. However, if you owe this tax and also owe any other additional tax on a distribution, don’t enter this 10% additional tax directly on your Form 1040, 1040-SR, or 1040-NR. You must file Form 5329 to report your additional taxes.
- If you rolled over part or all of a distribution from a qualified retirement plan, the part rolled over isn’t subject to the tax on early distributions.
- You have a qualified disaster distribution.
4.8. Additional Support
Consider reaching out to income-partners.net for more support in navigating retirement plans. At income-partners.net, we equip you to make the best decisions when approaching retirement.
5. Required Minimum Distributions (RMDs)
Once you reach age 73 (or 70½ if you were born before July 1, 1949, or 72 if you were born after June 30, 1949, but before January 1, 1951), you must begin taking required minimum distributions (RMDs) from your traditional IRA. The amount of your RMD is based on your age and the balance in your IRA at the end of the previous year.
5.1. What Is the Required Beginning Date?
If you are the owner of a traditional IRA, you must generally start receiving distributions from your IRA by April 1 of the year following the year in which you reach your applicable required beginning date. See the following to determine your applicable required beginning date:
- Age 73 for tax years 2023 and later. If you were born after December 31, 1950, but before January 1, 1959, you must begin receiving required minimum distributions by April 1 of the year following the year you reach the age 73.
- Age 72 for tax years 2020, 2021, or 2022. If you were born after June 30, 1949, you must begin receiving required minimum distributions by April 1 of the year following the year you reach age 72.
- Age 70 ½ for tax years 2019 or earlier. If you were born before July 1, 1949, you were required to begin receiving required minimum distributions by April 1 of the year following the year you reach age 70 ½.
5.2. Distributions after the Required Beginning Date
The required minimum distribution for any year after the year you reach age 73 must be made by December 31 of that later year.
5.3. IRS Tables
To calculate your RMD, you’ll need to use the IRS’s Uniform Lifetime Table, which provides a distribution period based on your age. Divide your IRA balance by the distribution period to determine your RMD.
5.4. Table III (Uniform Lifetime).
Use Table III if you are the IRA owner and your spouse isn’t the sole designated beneficiary or if your spouse is the sole designated beneficiary of your IRA and not more than 10 years younger than you.
5.5. Consequences of Not Taking RMDs
Failing to take RMDs can result in a significant penalty. The IRS can impose a 25% excise tax on the amount that should have been withdrawn but wasn’t. To avoid this penalty, it’s essential to calculate and take your RMDs each year.
5.6. What If I Make a Reasonable Mistake Regarding Insufficient Distributions?
You may be subject to a reduced additional tax rate of 10% of the amount not distributed, if, during the correction window, you take a distribution of the amount on which the tax is due and submit a tax return reflecting this additional tax.
The “correction window” ends on the earliest of the following dates:
- The date of mailing the deficiency notice with respect to the imposition of this tax, or
- The date the tax is assessed, or
- The last day of the second taxable year that begins after the end of the taxable year in which the additional tax is imposed.
6. Inherited IRAs
If you inherit a traditional IRA, you’ll generally need to include the distributions you receive in your gross income. However, the rules for inherited IRAs can be complex, depending on your relationship to the deceased and when they passed away.
6.1. Federal Estate Tax Deduction
A beneficiary may be able to claim a deduction for estate tax resulting from certain distributions from a traditional IRA. The beneficiary can deduct the estate tax paid on any part of a distribution that is income with respect to a decedent. They can take the deduction for the tax year the income is reported.
6.2. Date the Designated Beneficiary Is Determined
Generally, the designated beneficiary is determined on September 30 of the calendar year following the calendar year of the IRA owner’s death. In order to be a designated beneficiary, an individual must be a beneficiary as of the date of death. Any person who was a beneficiary on the date of the owner’s death, but isn’t a beneficiary on September 30 of the calendar year following the calendar year of the owner’s death (because, for example, they disclaimed entitlement or received their entire benefit), won’t be taken into account in determining the designated beneficiary.
6.3. Spousal Beneficiaries
If you inherit a traditional IRA from your spouse, you generally have two options:
- Treat the IRA as your own: You can roll the funds into your own IRA and treat it as if it were your original IRA.
- Treat yourself as a beneficiary: You can keep the IRA as an inherited IRA and take distributions according to the beneficiary rules.
6.4. Non-Spousal Beneficiaries
If you inherit a traditional IRA from someone other than your spouse, you can’t treat the IRA as your own. Instead, you must take distributions according to the beneficiary rules.
6.5. RMD rules for beneficiaries
If the original owner died before January 1, 2020, you generally have two options:
- The five-year rule: The entire IRA must be distributed within five years of the owner’s death.
- The life expectancy rule: Distributions must begin by December 31 of the year following the owner’s death, and they must be taken over your life expectancy.
6.6. 10-year Rule
The 10-year rule requires the IRA beneficiaries who are not taking life expectancy payments to withdraw the entire balance of the IRA by December 31 of the year containing the 10th anniversary of the owner’s death. For example, if the owner died in 2024, the beneficiary would have to fully distribute the IRA by December 31, 2034.
The 10-year rule applies if (1) the beneficiary is an eligible designated beneficiary who elects the 10-year rule, if the owner died before reaching their required beginning date; or (2) the beneficiary is a designated beneficiary who is not an eligible designated beneficiary, regardless of whether the owner died before reaching their required beginning date.
.If you are a beneficiary of an inherited traditional IRA and you do not take the required minimum distribution for the year, discussed in this chapter under When Must You Withdraw Assets? (Required Minimum Distributions), you may have to pay an excise tax for that year on the amount not distributed as required. For details, see Excess Accumulations (Insufficient Distributions) under What Acts Result in Penalties or Additional Taxes, later in this chapter..
6.7. Seeking Professional Advice
Navigating the rules for inherited IRAs can be challenging. Consulting with a tax advisor or financial planner is often the best way to ensure you’re meeting all the requirements and minimizing your tax liability.
7. Prohibited Transactions
Engaging in certain transactions with your traditional IRA can disqualify the account and trigger immediate tax consequences. These are known as prohibited transactions and include things like borrowing money from your IRA or using it as security for a loan.
7.1. Borrowing Money on an Annuity Contract
If you borrow money against
