RMDs, IRAs and more: understanding taxation in retirement

It is a truism that we cannot escape death and taxes.  Let's talk about taxes! In the eyes of the IRS, there are three types of accounts: taxable, tax deferred and tax-free. Savings accounts at banks are examples of taxable accounts. The interest growth is taxable for the year that the interest is earned. Tax free accounts include Roth IRAs and certain State Bond accounts. In these accounts, the funds are deposited after tax and the growth is tax free.

Tax-deferred accounts are accounts in which 1) the funds are deposited into the account pre-tax, and the interest growth is deferred – this includes IRAs, 403B, 457, and 401k. These accounts present tax issues in retirement.

Because the contributions are pre-tax and the growth is deferred, there comes a time when the tax bill has to be paid. That time usually arrives when the employee is 70 and half.  At this age the employee must make the first required minimum distribution (RMD). Using a formula, the IRS sets the minimum amount that the employee must withdraw (distribution) from their account. This RMD occurs each year, with the distribution having to made before Dec 31 of each year.