Understanding IRAs Distribution

What is an IRA? An individual retirement account is a personal savings plan designed for you to set money aside for retirement. This saved money will become your retirement income. Your retirement income may also include Social Security benefits, pensions, money from annuities, insurance contracts, or profit-sharing plans. Retirement income will be reported to you on Form 1099-R; if it is Social Security benefits, it will be reported to you on SSA-1099 form. 

There are four types of IRAs:

• Traditional IRA – distributions are fully taxable.

• Roth IRA – distributions are tax-free and may be excluded from income if certain requirements are met.

• Savings Incentive Match Plans for Employees IRA (SIMPLE) – distributions are fully taxable.

• Simplified Employee Pension IRA (SEP) – distributions are fully taxable.

In this article, I will briefly discuss traditional IRAs.

There are two advantages for having an IRA:

1. Any money you contribute to your IRA may be fully or partly tax deductible.

2. Money that is earned or gained in your IRA will not be taxed until it is withdrawn (distributed).

Contribution to an IRA means that you have put money away into an account in order to accumulate tax-deferred gains or earnings during the growth years. When you later retire, you will pay taxes on that income. Also, you will receive distributions from your IRA, which means withdrawals from that account will have to be set up for you to receive the required minimum distribution (RMD) for each year. If desired, you can have it set up to be withdrawn to you monthly in your retirement.

You can start withdrawing at 59 ½ or wait until full retirement age at 73. You must start receiving distributions (RMD) by April 1st of the following year you reached age 73. For example, you turned 73 years old on September 3rd of 2025; the next year, April 1st of 2026 (7 months later) is when you have to start receiving distributions from your traditional IRA. If you do not take RMD by April 1st, it will result in a tax penalty of 25% of what you should have withdrawn.

What are nondeductible contributions?

Nondeductible contributions are contributions that does not offer a tax deduction because taxes were NOT deducted before contributing to your retirement plan (think of gross pay). These funds are tax-deferred until retirement where you would then pay taxes on any gains received. The earnings or gains received will then be your taxable portion of the plan when you retire. This is a good strategy for individuals that has a high-income level and does not qualify for deductible contributions. You will need Form 8606 to carefully keep track of your nondeductible contributions.

Pre-tax, also known as Before-tax Deductions

Before-tax (or pre-tax) means that the employee did NOT have taxes taken out of their check for this money amount at the time it was contributed to their retirement account. These contributed funds are considered tax-deferred because you will pay taxes on it later when you retire. Your money in a traditional IRA will grow tax free in the meanwhile, but once you retire, your funds will then be taxed. Your funds will be distributed yearly and is treated as ordinary income which means you will have to pay taxes on your distributed funds (think of it as a paycheck in retirement years).

After-tax Deductions

After-tax means the employee has already paid taxes on the money when it was contributed to the retirement account, (think of it as net pay) and the distribution will be partially taxable. This money that is contributed into your retirement account can grow tax-free until you withdraw your funds in retirement. But any gains earned during the growth years while you are still working is taxable because the gains were not previously taxed, making it the “partially” taxed portion of your account.

In summary, the whole purpose of an IRA is to save money now by reducing your taxable income to reduce your tax bill (tax liability). Your money will temporarily grow tax-free in this type of IRA until you retire. Also, it allows you to put money aside that will grow in the market so that you have an income in your retirement years.

Information in this article is intended for educational purposes to provide general tax information; it does not provide you with tax advice or law. We do not provide specific counsel to you on deductions, business income or expenses. It is recommended to seek your tax professional or consultant on your specific tax and/or financial matters.

Information derived from Your Federal Income Tax (2024).