The Tax Liability on Taking Money Out of an Investment

The "where" of your investment is more important than the "what."

The "where" of your investment is more important than the "what."

Your tax liability for taking money out of an investment depends a lot more on what type of account the investment is in, such as an IRA, than on what the investment is, such as a mutual fund. Once you understand the tax ramifications of each type of account, you can better estimate your potential tax liability.

Traditional IRA

Let's say that your investment consists of 1,000 shares of a particular mutual fund (let's call it High Performance Fund) in your IRA. Selling your shares in this investment and taking out the money will likely cost you the most in taxes compared to any other option. You will owe income taxes on every dollar that is removed from the account as if it were regular income. If your annual earnings put you in the 28 percent tax bracket, this additional money will be taxed at your highest marginal rate, or 28 percent. You'll also have to cough up an additional 10 percent to pay the penalty on the amount withdrawn if you don't qualify for an exception, such as a withdrawal to help pay for your first home; or for your education; medical expenses that exceed 7.5 percent of your income; or disability..

Roth IRA

Assuming your 1,000 shares of High Performance Fund are in a Roth IRA, you can sell your shares and remove an amount that does not exceed your original contributions at any time, without penalty or taxes. If your fund lost money, this could be less than your contributions. But if the investment did really well and you want to remove all of the money, including your earnings, you'll pay income taxes plus the 10 percent tax penalty on the earnings unless your withdrawal qualifies for an exception. Other considerations and rules might apply, particularly if you converted a Traditional IRA to a Roth, so consult with a qualified tax expert for your particular situation.

Exceptions

If you're lucky enough to qualify for an exception to the 10 percent penalty for your IRA withdrawal, you'll still have to pay income taxes on the withdrawal from the Traditional IRA, but you likely won't owe anything on your Roth IRA withdrawal. If you think you qualify for an exception, consult with a qualified tax expert for help.

Taxable Investment Accounts

Now let's say that your 1,000 shares of High Performance Fund are in a taxable brokerage or mutual fund account. In that case, you need to know the investment's gain or loss to determine your tax liability. You won't need to pay any taxes on the amount originally spent for the shares, called your basis. If your investment lost money, you can declare the loss and potentially decrease your tax liability. If the investment made money, called a capital gain, you will pay taxes only on the amount the investment gained. For investments held longer than one year, the top tax rate on capital gains is 15 percent (your rate could be lower, depending on your income). For investments held less than one year, your capital gains will be taxed like regular income.

Insurance Policies

If you're tapping money from an insurance policy that has a cash value, such as whole, universal or variable universal life, you'll only pay taxes on the portion that's more than you've already paid into the policy, taxable to you as regular income.

About the Author

Julia Thomson began writing professionally in 1996. Her work has appeared in "Stage Directions," "Phoenix New Times" and "The Valley Callboard." Thomson has expertise in investing and personal finance, with three brokers' licenses and certification as a budget counselor. She holds a Master of Music from Indiana University.

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