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Individual retirement accounts generally give owners more flexibility than other types of retirement accounts, such as 401(k) plans, when it comes to withdrawals. However, even if you can access the money in your IRA, taking a distribution may cause more problems than it solves. IRAs are tax-advantaged accounts, meaning your withdrawal can trigger taxes and possible penalties. Any money you take out of your IRA prematurely will not be available for you in retirement.
IRAs are personal accounts established and maintained by individual investors. They stand in contrast to most other qualified retirement plans, such as pension plans, 401(k) plans and profit-sharing plans, which are established by employers on behalf of employees. If you open an IRA, you can take money out whenever you'd like, for any reason, as long as your funds last. Most employer-sponsored plans require you to demonstrate and immediate and heavy financial need to qualify for pre-retirement withdrawals.
Every time you take money out of a traditional IRA, you'll have to pay taxes on your distribution. These IRAs are funded with pre-tax money, meaning you were granted a tax deduction at the time of your contribution. As a result, no money in your IRA, neither your contributions nor your earnings, has ever been taxed and becomes taxable upon distribution. An exception is if you opened a Roth IRA, which does not grant a tax deduction on contributions and typically allows tax-free withdrawals. However, you will have to pay tax on any Roth earnings you withdraw in the first five years after you open the account.
Because the money in your IRA is meant for retirement, the Internal Revenue Service penalizes you for "early" withdrawals, defined as those taken before age 59 1/2. On top of any taxes you owe, early IRA distributions trigger a 10 percent penalty. For traditional IRAs, the penalty applies to your entire distribution; the penalty for Roth accounts only applies to the earnings portion of any withdrawal, not the return of contributions.
Once you reach age 70 1/2, the IRS requires you to take distributions from a traditional IRA. While you are still free to take out money as often as you like, after you reach this age, the IRS requires at least one withdrawal per calendar year. The minimum amount is based on your life expectancy and your account value. If you don't take out the money, you'll be hit with a 50 percent tax on the amount you should have taken.
- nest egg image by Jake Hellbach from Fotolia.com