Traditional individual retirement accounts were created in 1974 to offer people without an employer plan tax-sheltered retirement savings. All contributions to traditional IRAs grow tax-free as long as the money remains in the account. However, the Internal Revenue Service has rules and regulations for who can contribute, when distributions can be taken and even when distributions must be taken.
Traditional IRAs have two tiers of eligibility: contribution eligibility and deduction eligibility. To contribute, you must have compensation and you can't turn 70 1/2 before the end of the calendar year. To deduct your contribution, one of two things must be true. First, neither you nor your spouse can participate in an employer-sponsored retirement plan. Second, if either of you are covered, your modified adjusted gross income must fall below the annual limits for your filing status.
The IRS limits your annual traditional IRA contributions to the smaller of your compensation or the annual limit. The annual limit updates with inflation. If you're 50 or older, you're eligible to contribute an additional amount above the standard contribution limit. For example, in 2012, the standard contribution is limit is $5,000, but if you're 50 and up, it's $6,000. IRA contribution limits are cumulative, meaning even if you have two IRAs, you can only contribute $5,000 or $6,000 total . Also, any contributions made to a Roth IRA decrease the amount you can contribute to a traditional IRA.
Qualified distributions from traditional IRAs require that you be 59 1/2 or older when you make the withdrawal. You'll still have to pay ordinary income taxes on qualified distributions, but you won't owe any penalties. If you take a non-qualified distribution, you'll also owe a 10 percent additional tax penalty. For example, if you take out $3,000 early, you'll owe $300 unless an exception applies. For traditional IRAs, exceptions include permanent disabilities, up to $10,000 for a first home purchase, higher-education costs, medical expenses exceeding a minimum percentage of your adjusted gross income, and health insurance costs while unemployed.
Required Minimum Distributions
Beginning in the year you turn 70 1/2, you must start taking required minimum distributions from your traditional IRA. The amount depends on the size of your account and your age. As you get older, you must start removing a larger percentage of the account each year. If you don't take out the required amounts each year, you'll owe a 50 percent penalty. For example, if you forgot to take out $20,000, you'll owe a $10,000 tax penalty.
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