Taxes and Retirement Planning

If you have ever completed your tax return to find out that you owe the federal government thousands of dollars, and haven’t learned this painful lesson yet, you should read the following in order you don’t end up owing the IRS thousands and so begin taxes and retirement planning now.

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There is one important sign that hangs in the tax accountant’s office and you must remember it: “Never take money out of your retirement plan!” Of course it is an overstatement, but it is clearly understood why the accountant had such a sign in his office he wrote that as probably too many times he has to console crying or angry clients after explaining to them that they owed the government thousands of dollars because they withdrew money from their retirement or pension plan. The worst part is that these people that withdrew were often already facing immense financial problems - job losses, foreclosures, and bankruptcies.

Firstly you will find out that the law requires retirement plan administrators to withhold 20 percent of your money for the federal government, if you take money out of your pension or retirement plan. Of course, most people are upset by this news and believe withholding this amount will cover their tax bill as it is a considerable sum of money.

If you’re in the 28 percent tax bracket, you’ll owe the federal government another 8 percent of the amount you withdraw. Most taxpayers still need to worry about more federal and state taxes due. Worse yet, if you’re under 591/2 years of age, you’ll most likely be penalized another 10 percent. There is also another thing that in addition, most states will tax you 5 to 10 percent.

Now you probably wonder how will this affect your tax bill. If you withdraw $20,000, the plan administer will withhold 20 percent, leaving you with $16,000. Soon you’ll realize that you owe another $3,600 to the federal government and $1,500 to the state. It actually means that by taking out $20,000 of retirement savings, you end up with only $10,900. Now you can understand the previously mentioned sign much better.

There is no doubt that there also are exceptions. Those 10 percent penalty could be avoid in some different ways, for example using the retirement proceeds for tuition, medical costs, or to buy your first time home (up to $10,000). It should be added that some states don’t have an income tax and, naturally, these penalties and taxes don’t apply to ROTH Individual Retirement Accounts.

Your tax advisor will be able to explain to you the financial consequences that specifically pertain to your situation and even some alternatives could be suggested.

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