When talking about retirement planning, most of the focus is on how and where you’ll be saving money. While that should be your primary concern, you also need to figure out what comes after - withdrawing money to fund your retirement. 
In this article, we’ll talk about the different rules regarding traditional and Roth IRA withdrawals. Depending on your situation and your needs in retirement, you can maximize your earnings while minimizing your tax burden. Here are the tips that you need to know.
Traditional IRA vs. Roth IRA: What’s the Difference?
The primary difference between these two accounts is your tax burden. Traditional IRAs benefit you in the year you contribute because their contributions are tax-deductible, while Roth IRAs help you in retirement because their withdrawals are tax-free. Here is a brief comparison of the two options.
Contribution Limits
No matter what kind of IRA you have, the maximum amount you can contribute in a single year is $6,500 for 2023. If you’re over 50, you can put an additional $1,000 (again, that’s the total for the year). Roth IRAs have income requirements and Traditional IRAs have income requirements for tax-deductibility, which we’ll get into later.
Tax Deferment
Traditional IRAs allow you to claim contributions against your modified adjusted gross income (MAGI). By doing this, you can lower your taxable income for the year. We’ll discuss what happens to your taxes once you withdraw the funds later.
Tax-Free Growth
Technically, both IRA accounts grow tax-free. However, Roth IRAs don’t incur taxes at any point, provided that you’re over 59 1/2 when withdrawing. However, you don’t get to deduct your contributions into a Roth IRA.
How to Maximize Your IRA Withdrawals
Don’t Withdraw Early
If you’re not 59 1/2 yet, then any money you take out of a Traditional IRA will not only be taxed but hit with a 10% penalty. Once you reach this age, you can withdraw as much as you want. However, it’s usually better to wait until you’re retired so that the funds can grow even more.
With Roth IRAs, you can take out any money you’ve contributed at any time, tax-free. This is because you already paid the taxes on your contributions. However, you can get hit with a tax bill and penalty for any account earnings if you’re under 59 1/2. So, if you put away $1,000 in a Roth and it earned $200, you would pay taxes and a 10-percent penalty on that $200 if you’re under 59 1/2.
That being said, there are some extenuating circumstances where the penalty can be waived. Here is a brief overview of these scenarios.
First-Time Homebuyer
According to the IRS, an individual can take out up to $10,000 from an IRA during his or her lifetime for the purchase of a new home. However, to qualify as a “first-time buyer,” you or your spouse cannot have bought a property within the last two years. So, technically speaking, you could use the money for a second or third home, provided that it’s been longer than two years since your last purchase.
Another thing to keep in mind is that the property doesn’t have to be in your name. Spouses, children, and grandchildren can also receive the money for a home purchase. The only other restriction is that you have to use the funds within 120 days. So, be sure you time the withdrawal right.
Adoption or Birth of A Child
The Setting Every Community Up for Retirement Enhancement Act (SECURE) of 2019 changed some of the rules regarding IRA withdrawals and contributions. Now, individuals and couples can take out up to $5,000 the year after a birth or adoption. Spouses can each withdraw $5,000, for a total of $10,000.
The other benefit of this withdrawal is that you can replace the money later on without it counting against your annual contribution limit. So, if you took out the $5,000 this year, you could contribute up to $11,000 any year after.
Healthcare Expenses
With a traditional IRA, you can withdraw funds to pay for a non-reimbursed medical bill that exceeds 7.5-percent of your AGI. Any amount below that has to be paid from other funds. So, for example, if you make $100,000 per year, your IRA funds can cover a single medical bill over $7,500. But, that’s not to say it will pay off the whole thing. If, say, the amount is $8,000, your IRA money can go toward the excess $500 only.
Another option is to use IRA funds to cover healthcare premiums when you’re unemployed. Better yet, you can also cover premium payments for spouses and children. If and when you start working again, there is a 60-day limit. After that period, you can’t take any more withdrawals without the penalty.
Permanent Disability or Death
If you become disabled, the IRS will allow you to take money out of an IRA penalty-free. However, the disability has to be permanent - not temporary.
Substantially Equal Periodic Payments (SEPP)
With both types of IRAs, you can work with the IRS to set up a SEPP (72t) plan. In this case, you’re required to take a distribution every year until the program is complete. You can’t skip a distribution, and the payments will be the same each time.
If you choose this option, you have to be sure that you need it. Once it starts, it can’t be stopped until the plan ends.
Reservist Distribution
Those who are in the military and called for active duty for more than 179 days can take money out of an IRA penalty-free. However, the funds have to be withdrawn while you’re on duty, not after you return home.
Avoid Double Distributions
According to SECURE Act 2.0, individuals must now take IRA withdrawals at age 73. Your first required minimum distribution (RMD) is due by April 1st of the year after you turn 73. Starting in 2033, the age when RMDs start increases to age 75.
However, you will also have to take another RMD by December 31st of that year. So, to avoid double-dipping (and paying twice as many taxes), it could be better to withdraw your first RMD the same year you reach 73 depending on your tax situation. Also, considering that you could get into a higher tax bracket by taking a double distribution, you could save even more money this way.
Contribute to Your Roth Even While Withdrawing From a Traditional IRA
Roth IRAs are unique in that there is no maximum age limit. So, no matter how old you are, you can put money away. Since these funds are all tax-free after age 59 1/2 (even investment earnings), it’s best to contribute as often as possible.
As we mentioned, there are income requirements for Roth accounts. The 2023 totals are as follows:
For Individuals
Those making $138,000 or less per year can contribute the maximum amount of $6,500. Income between $138,000 and $153,000 will result in a lower threshold. If you earn above $153,000 (MAGI), you can’t put money into a Roth at all.
For Couples Filing Jointly
The maximum earnings for a full contribution are $218,000. Income between $218,000 and $228,000 will have a lower threshold, and any couples making more than $228,000 don’t qualify.
Convert Money From a Traditional IRA Into a Roth
Because Roths don’t have RMDs, the money can grow tax-free forever. So, if you want to keep your IRA investments building during retirement, you can convert your Traditional IRA funds into a Roth IRA. Some things to keep in mind, though:
- You will have to pay taxes. It’s generally not ideal to roll all of the funds at once since the tax bill could be rather large. Instead, you may want to space it out over several years.
- Be sure to consider your AGI. Since your converted funds will be taxed as income, they could potentially put you into a higher tax bracket. Make sure you stay within your current bracket. Ideally, you can convert the money over during retirement when your income is substantially lower.
- Don’t forget about the stock market. In a perfect scenario, you’d convert your funds when the market is down, so that those funds can build back up tax-free in the Roth IRA.
Make a Charitable Contribution
If you donate your RMD funds to a charity, you don’t owe any taxes on it. For example, if you’re trying to keep your MAGI under a specific total, you can donate the excess and avoid a higher tax burden for the year. Remember, those RMD’s must go directly to the charity.
Start Withdrawing Before Your RMD
Finally, if you’re between the ages of 59 1/2 and 73, you can start taking money out of an IRA without the penalty. At first, this may seem counterintuitive, but there are two primary benefits of doing this.
First, you can lower the total in your IRA, which will reduce your RMD and potential tax bill.
Second, you can convert the money into a Roth IRA or other long-term investment account. This way, the funds will grow during your retirement, and you don’t have to take it out before you’re ready.
Contact NextGen Wealth Today
Making the most of your IRA money can seem complicated at first, which is why you want a financial advisor in your corner. At NextGen Wealth, we’ll work with you to help make the right moves for your situation. Contact us to find out more and see how we can ensure that you’ll keep more of your money.