How Federal Withholding Requirements Apply to IRA Distributions
By Stacy Torkelson, CIP, CHSP, CFC
Are IRA distributions subject to federal withholding?
Yes, but how withholding is applied depends on whether the distribution is considered periodic or nonperiodic. Periodic payments are the minority of IRA distributions, encompassing only annuitized distributions from IRA annuities. These payments are treated as wages for withholding purposes. All other IRA distributions are considered nonperiodic payments and are subject to withholding at a default rate of 10 percent, which generally can be waived by the IRA owner or she can request a greater amount.
Are IRA owners always allowed to waive withholding on IRA distributions?
The ability to waive withholding will depend on whether the IRA owner is a U.S. citizen or resident alien, or a nonresident alien. U.S. citizens and resident aliens can generally waive withholding on IRA distributions. But there are certain situations when these IRA owners will not be permitted to waive withholding and a mandatory 10 percent rate of withholding will apply.
Guidance from IRS Notice 87-7 addressed situations that would require mandatory withholding, specifically when the IRA owner has a residence address outside of the United States or does not provide an actual residence address, such as a post office box. This guidance is relatively old, however, and does not address situations that may arise more frequently in modern financial markets where payments are more likely to be made across international borders.
To clarify these requirements further, proposed Treasury regulations were issued in 2019. Specifically, these regulations state that withholding is required in the following situations.
The IRA owner requests a distribution be paid to a foreign bank account (even if the IRA owner provided a U.S. residence address).
The IRA owner requests a distribution be paid to a U.S.-based bank account but the IRA owner has a foreign residence address.
The IRA owner does not provide a U.S. residence address.
The regulation notably exempts military and diplomatic personnel who are outside of the United States from this requirement, as it states that any Army Post Office, Fleet Post Office, or Diplomatic Post Office address is considered to be a U.S. residence address for withholding requirements purposes.
What are the withholding requirements for nonresident aliens?
The withholding rules require mandatory withholding of 30 percent for distributions to nonresident aliens unless the individual provides the financial organization with a completed Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting (Individuals), and claims a lower withholding rate based on the tax treaty between his country of residence and the United States. For example, a Canadian citizen resident would be subject to 30 percent withholding, unless he completed Form W-8BEN. Then the financial organization could withhold at the Canadian tax treaty rate of15 percent.
Do the withholding rules apply to Roth IRA distributions?
The withholding rules apply to any IRA distribution that is potentially taxable. In many cases Roth IRA distributions will not be taxable. Only “qualified” distributions—based on account and customer information at a given financial organization—are certain to be tax-free. All other distributions—those that are nonqualified or might not consist of a Roth IRA owner’s tax-free contributory basis—could be subject to tax. As a result, the federal withholding rules are generally applied to Roth IRA distributions. Keep in mind that a distribution recipient may still waive withholding if they wish.
