How Does an IRA Work & When Can You Withdraw?

by Tom Streissguth

    Unless you plan to work until the day of your demise, it's smart to save a little -- or a lot -- for retirement. Steady income from an investment account will help you maintain a comfortable, post-work standard of living; you can also benefit members of your family by naming them heirs to the account. The individual retirement account, or IRA, is a popular "tax-advantaged" way to sock away your retirement savings.

    Traditional vs. Roth IRAs

    The IRA is available as a "traditional" or Roth account. In the traditional version, you can deduct contributions to the account up to an annual limit set by the IRS. In 2012, $5,000 if you are under 50 years of age and $6,000 if you are 50 or over. When you start withdrawing the money, the gain on the account -- meaning dividends, interest, and capital gains -- is subject to income tax; since you aren't expected to be earning as much in salary or wages at that time, your income tax rate should be lower. In a Roth IRA, the contribution limits are the same, but they are not deductible; the account income is tax-free when you make withdrawals.

    Early Withdrawal Penalty

    You can withdraw IRA funds at any time, but if you take the money out before you reach the age of 59 and a half, the IRS levies a 10 percent penalty as well as income tax on the account gain, if it's a traditional IRA. To avoid this costly situation, you must return the money within 60 days of removing it. In addition, the IRS allows a few penalty-free "hardship" withdrawals in the case of emergency medical expenses, higher education expenses, your permanent and total disability, to pay health insurance premiums if you're unemployed, or to buy a first home, with a $10,000 limit. In case of your death, your beneficiaries may also take penalty-free withdrawals.

    Periodic Payments

    If you need steady income before you reach 59 and a half, the IRS also allows penalty-free withdrawals as long as you take them as substantially equal periodic payments. The period can be monthly, quarterly or annually. You must take the payments over at least a five-year period, or until you reach 59 and a half. The IRS levies income taxes if it's a traditional IRA, but no penalty.

    Retirement Withdrawals and RMDs

    Once you've passed 59 and a half, you're free to withdraw as much or as little as you need from your IRA. When you get to 70 and a half, however, the IRS requires withdrawals from traditional IRA accounts (not from Roths). You can delay taking these withdrawals until April 1 following the year in which you turn 70 and a half. The amount of these required minimum distributions depends on your life expectancy: you divide the account value by the number of years you are expected to live, according to IRS actuarial tables. If you fail to take the RMD, the IRS can levy up to 50 percent in excise tax on the amount that you should have withdrawn but did not.

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    About the Author

    Tom Streissguth has worked for over 15 years in the legal field as a writer and legal assistant, and has authored numerous articles on Social Security disability law. He has many nonfiction and reference titles in print, including works for The Gale Group and Lerner. He holds a Bachelor of Arts from Yale University.

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