Tax-qualified retirement plans allow people to save for retirement by deferring the taxes on their growth. Some plans, such as a traditional individual retirement account, provide tax deductions for contributions, while restricting when and how much someone can contribute. Roth IRAs work have some similarities to traditional IRAs, but they have different rules on who can contribute, and when.
Required Minimum Distribution
Traditional IRAs allow people to contribute on a pretax basis to an account that grows tax-deferred. By providing a deduction for contributions, subject to some eligibility requirements, the Internal Revenue Service doesn't collect any taxes on a traditional IRA until money is withdrawn. In return, the IRS requires account holders to take annual distributions from their IRA starting at age 70 1/2, and to pay taxes on those distributions.
Traditional IRAs have contribution age limits in addition to dollar limits, preventing participants from taking their required minimum distributions and reinvesting them in another traditional IRA. Once an account owner reaches 70 1/2 and must start taking required minimum distributions, she no longer can contribute to a traditional IRA. The deductibility of contributions to traditional IRAs is also subject to earning limits that change year by year.
Unlike traditional IRAs, Roth IRAs are not eligible for tax-deductible contributions. In exchange, qualified withdrawals from a Roth IRA are tax-free. Because contributions to Roth IRAs are made with after-tax dollars and withdrawals can be tax-free, the IRS does not require distributions. Additionally, there are no age limits on contributions to a Roth IRA. So you can fund a Roth IRA with required minimum distributions from a traditional IRA.
To reap the tax-free growth of a Roth IRA, distributions must meet certain qualifications. Anyone who must take a required minimum distribution from a traditional IRA will automatically meet the age criterion, since required minimum distributions start 11 years after first becoming eligible for penalty-free withdrawals at age 59 and a half. However, only earnings on money that's been in the Roth IRA at least five years can be withdrawn tax-free. Withdrawals also may be made be penalty-free if the owner dies, becomes disabled or purchases a first home. The principal in a Roth IRA can always be withdrawn free of tax and penalty.
Sean Butner has been writing news articles, blog entries and feature pieces since 2005. His articles have appeared on the cover of "The Richland Sandstorm" and "The Palimpsest Files." He is completing graduate coursework in accounting through Texas A&M University-Commerce. He currently advises families on their insurance and financial planning needs.