How Retirement Account Withdrawals Affect Your Tax Bracket
Retirement Tax Brackets: How Retirement Account Withdrawals Affect It
Can withdrawals from retirement accounts put you into a higher tax bracket? That depends on the type of account and the size of your withdrawals.
The most advantageous type of account, from the retiree’s viewpoint, is the Roth IRA or Roth 401(k). Taxes on money that goes into these accounts are due at the time they are paid in. Taxes on withdrawals after retirement are tax-free on the entire amount, including the profits.
Traditional IRAs and 401(k)s work differently: You get an upfront tax break when you contribute but then pay taxes on the withdrawals during retirement. And those withdrawals are taxed as ordinary income, possibly pushing you into a higher tax bracket in retirement.
- Withdrawals from traditional IRA and 401(k) account withdrawals are taxable.
- Withdrawals from Roth IRAs and Roth 401(k) generally are not taxable.
- This means that retirement account withdrawals can bump you into a higher marginal tax bracket.
- You won’t pay higher taxes on your other income, just on the retirement account withdrawals. That’s the way marginal tax brackets work,
- If you’re withdrawing money from a traditional account, keep an eye on your tax bracket. You may be able to limit your withdrawals to avoid exceeding your bracket’s maximum.
Traditional IRA and 401(k) Accounts
Traditional IRA and traditional 401(k) accounts are funded with pre-tax dollars.
That is, you can deduct your contribution to a traditional IRA every year. That reduces your taxable income for the year while funding your retirement.
If it’s an employer-sponsored traditional 401(k), you don’t even have to claim the deduction. Your 401(k) contributions generally come directly out of your paycheck, using pre-tax dollars. This lowers your taxable income for the year—and saves you money at tax time.
With either type of account—a traditional IRA or 401(k)—your contributions and earnings grow on a tax-deferred basis until you eventually withdraw the money in retirement.
Required Minimum Distributions
While you might want to leave your nest egg alone well after retiring, you’re not allowed to do that with a traditional account. Starting at age 72, you have to take required minimum distributions (RMDs) each year or face a severe penalty.
When you start taking withdrawals, those amounts are included in your taxable income for the year and taxed as ordinary income. When added to your income from other sources, those retirement account withdrawals could push you into a higher marginal tax bracket.
The SECURE ACT of 2019 changed the rules for required minimum distributions (RMDs) for the better. Previously, the RMD kicked in at age 70½, but that has now been raised to 72.
Roth IRA and Roth 401(k) Accounts
By contrast, Roth IRA and Roth 401(k) accounts are funded with after-tax dollars, so you don’t get an upfront tax break. However, the money you withdraw from them—both your initial contributions and any investment earnings—will be tax-free in retirement, as long as you meet a couple of conditions.
You can withdraw your contributions from a Roth-type account at any time, for any reason, with no tax implications or penalties. But your investment earnings will be tax-free only if you are at least 59½ years old and it has been at least five years since you first contributed to any Roth IRA or Roth 401(k) you own. That’s called the “five-year rule.”
No Required Minimum Distributions
Any investment earnings you withdraw early will be added to your income for the year and taxed at your ordinary-income tax rate. You may also incur an additional 10% penalty unless you qualify for an exception.
Unlike traditional IRAs and 401(k)s, the Roth versions don’t require required minimum distributions during the owner’s lifetime. So, if you don’t need the money, you can leave it alone and let the account grow tax-free for your heirs.
Heirs to a Roth account must take required minimum distributions from the account unless they are surviving spouses.
Penalty-Free IRA Withdrawals
If you take an early withdrawal from a traditional or Roth IRA, you may be on the hook for a 10% penalty—but not if one of these exceptions applies:
- You are totally and permanently disabled.
- You’re the beneficiary of a deceased IRA owner.
- You use the distribution to buy, build, or rebuild a home (a $10,000 lifetime limit applies).
- You have unreimbursed medical expenses that are greater than 7.5% of your adjusted gross income (AGI).
- You’re paying medical insurance premiums after losing your job (and the distribution isn’t more than the cost of the insurance).
- You’re taking the distribution to pay for qualified education expenses.
- The distribution is due to an IRS levy of the qualified plan.
- You’re taking qualified reservist distributions.
- You’re taking a series of substantially equal periodic payments.
401(k) Hardship Withdrawals
Like IRAs, an early withdrawal from a 401(k) can trigger a 10% penalty. However, you may be able to take a penalty-free withdrawal if you qualify for a hardship distribution due to “an immediate and heavy financial need.”
Under IRS regulations, you may qualify for a hardship distribution if you use the money to pay for:
- Medical care expenses
- Costs related to buying a home
- Educational expenses
- Costs to avoid eviction
- Funeral expenses
- Certain expenses to repair damage to your primary home
If you’re planning ahead for retirement, you can roll over a traditional account into a Roth account. You’ll have to pay the income taxes on the balance that year, though.
Tax Brackets for 2021 and 2022
You have to pay taxes on withdrawals from traditional retirement account withdrawals, but they won’t necessarily force you into a higher marginal tax bracket. It depends on what bracket you’re already in and how much those withdrawals add to your income.
Here’s a look at the tax brackets for 2021 (due April 18, 2022) and for 2022:
|2021 Tax Rates and Brackets|
|Tax Rate||Single Filers||Married Filing Jointly||Heads of Household|
|10%||Up to $9,950||Up to $19,900||Up to $14,200|
|12%||$9,951 to $40,525||$19,901 to $81,050||$14,201 to $54,200|
|22%||$40,526 to $86,375||$81,051 to $172,750||$54,201 to $86,350|
|24%||$86,376 to $164,925||$172,751 to $329,850||$86,351 to $164,900|
|32%||$164,926 to $209,425||$329,851 to $418,850||$164,901 to $209,400|
|35%||$209,426 to $523,600||$418,851 to $628,300||$209,401 to $523,600|
|37%||$523,601 or more||$628,301 or more||$523,601 or more|
Say, for example, you’re single and your other income adds up to $40,000. Your highest marginal tax bracket is 12%. But any additional income (such as from retirement account withdrawals) that pushes you over the $40,525 threshold would be taxed at the next marginal tax rate—22% in this case.
That doesn’t mean your entire income will be taxed at 22%. Because of the way marginal tax brackets work, the tax rates on your first $40,525 wouldn’t be affected—just anything above that.
For 2022, the percentages remain the same, but the income thresholds are slightly higher:
|2022 Tax Rates and Brackets|
|Tax Rate||Single Filers||Married Filing Jointly||Heads of Household|
|10%||$0 to $10,275||$0 to $20,550||$0 to $14,650|
|12%||$10,275 to $41,775||$20,550 to $83,550||$14,650 to $55,900|
|22%||$41,775 to $89,075||$83,550 to $178,150||$55,900 to $89,050|
|24%||$89,075 to $170,050||$178,150 to $340,100||$89,050 to $170,050|
|32%||$170,050 to $215,950||$340,100 to $431,900||$170,050 to $215,950|
|35%||$215,950 to $539,900||$431,900 to $647,850||$215,950 to $539,900|
|37%||$539,900 or more||$647,850 or more||$539,900 or more|
Do You Pay Taxes on Retirement Account Withdrawals?
If you have a traditional IRA or 401(k), you get an upfront tax break when you make a contribution, and your withdrawals are taxed as ordinary income.
There’s no upfront tax break for Roth IRAs and Roth 401(k)s. You pay the taxes due on that income as it’s paid into your account, but qualified withdrawals in retirement are tax-free.
Will My Tax Bracket Be Higher or Lower in Retirement?
Conventional wisdom says that your income, and therefore your tax bracket, should be lower after you retire. In general, experts estimate that you’ll need 70% to 80% of your pre-retirement income to live comfortably during retirement. With less income in retirement, you could end up being in a lower tax bracket.
But it’s not that simple.
First of all, tax rates in the future may be lower or higher than they are today, which could change your tax situation for better or worse.
Also, you may not have all the tax deductions you once had to offset your taxes. For instance, your home may be paid off, so you won’t be able to deduct mortgage interest. With the kids grown and gone, you can no longer claim them as dependents. The loss of deductions could put you into a higher tax bracket.
What Are the Federal Tax Brackets for 2022?
There are seven tax brackets for 2022. For single filers, the tax brackets are as follows:
- 10% for incomes less than $10,275
- 12% for incomes between $10,275 and $41,775
- 22% for incomes between $41,775 and $89,075
- 24% for incomes between $89,075 and $170,050
- 32% for incomes between $170,050 and $215,950
- 35% for incomes between $215,950 and $539,900
- 37% for incomes over $539,900
For married couples filing jointly, the tax brackets are as follows:
- 10% for incomes less than $20,550
- 12% for incomes between $20,550 and $83,550
- 22% for incomes between $83,550 and $178,150
- 24% for incomes between $178,150 and $340,100
- 32% for incomes between $340,100 and $431,900
- 35% for incomes between $431,900 and $647,850
- 37% for incomes over $647,850
The Bottom Line
Some people dream of achieving a zero tax bracket in retirement. It’s hard to imagine achieving that goal while maintaining even a minimally comfortable lifestyle. Income tax kicks in when an individual reports more than $10,275 in income (or $20,550 for a couple filing jointly). If your income exceeds $25,000, you even have to pay taxes on at least part of your Social Security income.
The trick is to minimize the amount of taxes you owe. One of the ways to achieve that is to invest in a Roth 401(k) or a Roth IRA rather than their traditional counterparts. If your money is now in traditional retirement accounts, you might consider a Roth IRA rollover before you retire. You’ll owe taxes on the balance you transfer that year, but the long-term effects could be beneficial.