One of the financial products you can invest in to save for retirement is an individual retirement account. An IRA is a savings vehicle that allows you to build retirement income faster due to several tax advantages. One of the tax advantages is your money grows on a tax-deferred basis. You also get to deduct your contributions to your IRA plan up to a certain limit on your individual tax return.
There are two types of distributions: qualified and non-qualified. Qualified distributions are withdrawals with no tax penalties. You can start getting qualified distributions when you reach age 59 1/2. If you’re not at this age, you can still get penalty-free withdrawals if you have a qualifying reason. For instance, you can get up to $10,000 from your IRA penalty-free if you’re purchasing your first home. Other reasons include a permanent disability or paying medical expenses that are more than 7.5 percent of your adjusted gross income, college tuition or insurance premiums if you’re unemployed for at least three months. If you’re not age 59 1/2 and don’t have a qualifying reason, any withdrawals from your IRA will incur a 10 percent penalty. In addition, you will have to pay taxes on the amount of the IRA distribution at your regular income tax rate.
Another type of IRA, a Roth IRA, works the opposite of a traditional IRA. Instead of making tax-deductible contributions and getting taxed on the distributions, you make non-deductible contributions with after-tax dollars to a Roth IRA and withdrawals are tax-free -- as long as your plan has been active for five years. Like a traditional IRA, you will be assessed a 10 percent tax penalty if you make withdrawals before 59 1/2 without a qualifying reason. You can leave your money in a Roth IRA for as long as you want, while the IRS requires you to make withdrawals from a traditional IRA once you reach age 70 1/2.
Modes of Withdrawals
There are several ways you can receive your IRA distributions. You can get paid on a monthly basis. You can take out partial or full lump-sum payments as well. These modes of withdrawals may require minimum amounts. For example, monthly distributions may have to be at least $100, while $500 may be the minimum withdrawal amount for lump-sum payments. Also, you can choose to withdraw just the interest earned on your IRA. These types of payments can be made to you quarterly.
When you’re required to take mandatory withdrawals from your traditional IRA, you must take a minimum amount each year, which is based on how much you’ve saved. To determine your minimum amount, you divide the account balance as of Dec. 31 of the prior year by the distribution period or life expectancy according to the IRS. The tables needed to calculate your minimum IRA withdrawal amounts are found on the IRS website. If you don’t start taking mandatory withdrawals after you reach 70 1/2, you can be hit with a 50 percent tax penalty on the amount not withdrawn as required.
- Comstock Images/Comstock/Getty Images