Income Taxation of Qualified Plans and IRAs in NJ
Although assets held in qualified plans and IRAs (Plans) generate no income tax liability, the distribution of those assets to a participant (P) or Ps beneficiaries does, generally at ordinary income tax rates on every dollar. The IRS also imposes "penalty" taxes on withdrawals made either too soon or not soon enough. If P withdraws assets from a plan before reaching 59 1/2, he or she will have to pay a 10% penalty tax in addition to the payment of ordinary income tax on the withdrawal (unless one of several limited exceptions applies). More onerous is the tax imposed if P does not make a required minimum distribution after reaching his or her "required beginning date" (RBD), which generally is April 1 of the year after the year in which P reaches age 70 1/2. On that date, P must make certain minimum withdrawals. If P does not do so, a 50% penalty tax is imposed on the amount that should have been withdrawn but wasnt (again, in addition to the ordinary income tax on the distribution).
In other words, there is potential tension between P, who may not want to make any Plan withdrawals even after the RBD, and the IRS, which wants withdrawals to be made and taxes to be paid. The good news is that, with proper planning, P can decrease the size of the required minimum distribution and increase the Plans income tax benefit.