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Posted by Mark Bole on July 18, 2009, 11:19 am
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Alan Meyer wrote:
> I have questions about the tax implications of gains or losses in
> retirement accounts.
[...]
> Now, here are the questions. They look hard to me, but I'm
> hoping there are easy to use answers:
>
> 1. When the investor distributes income back to himself from the
> plan, he's supposed to pay taxes on the income. How does he
> figure those taxes?
By including the distributions on lines 15/16 of Form 1040. There may
be additional excise taxes (penalties) if various rules related to
retirement age and so one are not met.
BTW, you are usually not distributing just "income" back to yourself,
but rather a portion of the entire balance in the account, regardless of
how much was contributed vs. how much was a gain/loss on the investment.
> Is each component of the investment income taxed at whatever
> rate he would pay if the income did not come from a
> retirement plan? Or is it all ordinary income?
All ordinary income.
> 2. If distributions are not just ordinary income, are they taxed
> at the then current rate at the time of the distribution, or
> at the rate when the income was earned?
>
> For example, if some dividends were earned when there was no
> special rate for dividends, and some after there was, is the
> income taxed at two different rates? This gets pretty messy
> when you try to trace the components of income at that fine a
> level.
You are taxed at your ordinary income rate when you take the money out,
which avoids all the complexities you mention.
This is the whole point of regular IRA or 401k -- you avoid paying
higher marginal tax rates on the income (earnings plus portfolio) during
your peak earning years, instead paying the presumably lower marginal
tax rates you are subject to in retirement. If this is *not* going to
be your situation, then these types of accounts are much less attractive
from a financial planning standpoint, almost to the point of, "why bother?"
This is also, why, for example it makes little sense to invest in
tax-exempt bonds inside a retirement account, you are essentially
wasting the tax-advantaged status of this type of investment.
If you want to take advantage of special capital gains tax rates and
capital loss deductions, keep your investments outside of a retirement
account.
> 3. If there was a capital loss, is that treated as an ordinary
> long term loss, set against long term gain?
No. A tax-deductible loss requires first that you have a "basis" (an
amount you have already paid tax on, roughly speaking). You never paid
tax on any of the money going into, or earned within, the account, so
you have no basis against which to calculate a loss (I'm leaving out
all the various rules and exceptions regarding non-deductible
contributions, etc).
IRS Pub 590 and Pub 525 might be good places to start. But I think once
you "get" the concept that the retirement plan (normally) contains 100%
pre-tax money, it's pretty clear that it's all taxable on the way out.
-Mark Bole
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