3675 / Are amounts received from IRAs subject to withholding?

Taxable distributions from traditional IRAs are subject to income tax withholding. If the distribution is in the form of an annuity or similar payments, amounts are withheld as though each distribution were a payment of wages pursuant to the recipient’s Form W-4. In the case of any other kind of distribution, a flat 10 percent must be withheld by the plan custodian unless a different withholding choice is elected by the owner.¹ A recipient generally can elect not to have the tax withheld; this election will continue until the recipient revokes the election.² Even though distributions from a traditional IRA may be partly nontaxable because of nondeductible contributions, the payor must report all withdrawn amounts to the IRS.³ For states that impose income tax on IRA distributions, state income tax withholding may also be required.

Distributions from Roth IRAs are subject to income tax withholding, but only to the extent that it is reasonable to believe the amount withdrawn would be includable in income.⁴

Planning Point: IRS withholding guidance, released in Notice 2018-14, could impact individuals who receive retirement benefits in the form of periodic payments (generally those that are annuitized). Individuals receiving periodic payments can use Form W-4P to waive or increase withholding, depending upon their expected income tax liability. With respect to periodic payments, the default method of withholding is based on whether the individual is single or married and the number of withholding allowances the individual could claim were the payments traditional wages. Under Notice 2018-14, the IRS has set the default withholding for periodic payments to equal the wage withholding of a married taxpayer who claims three withholding allowances in order to take the 2017 tax reform law into consideration. Individuals who receive periodic retirement payments may wish to examine their anticipated tax situation and use Form W-4P to modify this default treatment if appropriate.⁵

Planning Point: Starting in 2022, withholding elections were to be divided among two forms, Form W-4P and Form W-4R. The IRS delayed the effective date to January 1, 2023. The IRS has also released draft forms and instructions. Form W-4P will be used for withholding tax from periodic payments made from retirement plans and IRAs (the default withholding will be single, with no adjustments, if the taxpayer fails to provide a form). If the taxpayer is already receiving periodic payments, there’s no need to submit a new form if the taxpayer does not wish to make any changes. Form W-4R will be used to withhold federal tax from certain rollover distributions and non-periodic payments.⁶

For 2020, the IRS redesigned Form W-4, which previously mirrored Form W-4P, to account for tax reform changes. The IRS clarified that for 2020, the default rules for withholding from periodic payments under Section 3405(a) when no withholding certificate has been furnished will continue as in prior years (i.e., married with three allowances).

IRS regulations clarify tax withholding rules for periodic retirement and annuity payments. Pre-tax reform, the default withholding rate was based on a married taxpayer with three withholding exemptions. Post-reform, the personal exemption has been suspended and Congress directed the Treasury to provide updated withholding rules. The regulations add several Q&A to explain that amounts withheld will be treated as though the payment were part of wages paid by an employer. If the payee has not provided a withholding certificate, the withholding amount is determined based on a married taxpayer with three withholding allowances.⁷