How Retirement Account Withdrawals Affect Your Tax Bracket (2024)

Many retirement experts estimate that you'll need 70% to 80% of your pre-retirement income to live comfortably during retirement. But can withdrawals from retirement accounts put you into a higher tax bracket? They can, depending on the type of account and the size of your withdrawals.

From the retiree's viewpoint, the most advantageous type of account is the Roth IRA or Roth 401(k). Income taxes on money that is paid into Roth accounts are due when they are paid in, that is with after-tax dollars. Once the account holder retires, withdrawals are tax-free on the entire amount, including any earnings on the investments.

Traditional IRAs and 401(k)s work differently: You get an upfront tax break when you contribute but then owe taxes on your withdrawals during retirement. And those withdrawals are taxed as ordinary income, possibly pushing you into a higher tax bracket in retirement.

Traditional IRA and 401(k) Accounts

Traditional IRA and traditional 401(k) accounts are funded with pre-tax dollars. During your working years, you can reduce your taxable income for the year while putting aside the money to fund your retirement.

There are restrictions on how much money you can add to these accounts. For example, you may only invest up to $7,000 in a traditional account for the 2024 tax year. If you are age 50 or older, you can contribute an additional $1,000 in catch-up funds for a total of $8,000 in 2024.

The contribution for a 401(k) is $23,000 in 2024, plus the additional catch-up contribution of $7,500 for those age 50 and older.

Your traditional 401(k) contributions come directly from 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 after retiring.

Required Minimum Distributions

Assuming you haven't dipped into your retirement savings before age 73 or 75 (depending on the year you were born), you must take required minimum distributions (RMDs) each year after this point or face a stiff IRS penalty. Remember, you didn't pay income tax on that money, and the IRS wants it.

RMD withdrawals are treated as income and will factor into your tax bracket when you start taking them. In addition, the money is included in your taxable income for the year. Those retirement account withdrawals could push you into a higher marginal tax bracket when added to your income from other sources.

It is possible to postpone taking your RMDs if you invest in a particular type of deferred annuity. But there are rules. You may only spend up to $135,000 on the annuity using funds from your traditional IRA or 401(k) account. You can purchase aqualified longevity annuity contract (QLAC) and keep it within your retirement portfolio.

These funds are kept separate from the amount considered for your RMD withdrawals. However, fees may be high, and you cannot tap into the annuity's cash value if you need quick access to the cash in a lump sum.

Roth IRA and Roth 401(k) Accounts

Roth IRA and Roth 401(k) accounts are funded with after-tax dollars, so you don't get an upfront tax break like you do with traditional IRA and 401(k) accounts. 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 follow a couple of rules.

You can withdraw your contributions in 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). That's called the "five-year rule."

There are limits to how much you can deposit into a Roth account. Individuals who earn more than $161,000 in 2024 do not qualify for a Roth IRA. If you are part of a married couple filing jointly, the income limit is $240,000 in 2024.

Like a traditional IRA, you can only contribute the IRA maximum per year plus any eligible catch-up amounts if you are age 50 or older.

No Required Minimum Distributions

Investment earnings you withdraw early from a Roth retirement account will be added to your income for the year and taxed at your ordinary income tax rate. You may also incur a 10% penalty unless you qualify for an exception.

Unlike traditional IRAs and 401(k)s, the Roth IRA doesn't require required minimum distributions during the owner's lifetime. However, like traditional 401(k)s, the designated Roth 401(k) does require RMDs unless owners are still working and are not a 5% owner.

If you don't need the money and fit the Roth 401(k) exception, you can leave your funds alone and let the account(s) grow tax-free for your heirs.

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 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.

Other exceptions have been added from time to time. For instance, people who lost income due to the COVID-19 pandemic were permitted to make early withdrawals.

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

Tax Brackets for 2024

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 2024:

For example, you're single, and your 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 $47,150 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 $44,725 wouldn't be affected—just anything above that.