The traditional IRA is the original IRA, created in 1975 to help working Americans to save for retirement. Perhaps because the traditional IRA was the first attempt to structure a retirement account with tax advantages, it has more restrictive rules than the Roth IRA, which came into being decades later. Traditional IRA rules are meant to discourage savers from using the funds before retirement, and to ensure that the Internal Revenue Service receives tax revenue when money is withdrawn
Taxed as Income
All withdrawals from a traditional IRA, at whatever age, are taxed as income. On each distribution, you pay your income tax rate for that year. The rare exception is the withdrawal of non-deductible contributions. If you do make non-deductible contributions to your account, keep careful track of the dates and amounts. Your trustee does not track your non-deductible contributions. File IRS Form 8606 to report these contributions to the IRS.
Age 59 1/2 Rule
If you take money out of your traditional IRA before you reach age 59 1/2, the withdrawal is subject to a 10 percent early-withdrawal penalty. This penalty is added to the income tax. The sum of penalty and interest can reduce the value of your distribution by as much as 45 percent as of 2012.
Early-Withdrawal Penalty Exceptions
Exceptions to the age 59 1/2 rule do exist. During your lifetime, you can withdraw up to $10,000 penalty-free to buy a first home or to pay for college education. You can also use the money to pay for health insurance premiums while you are unemployed, or to cover medical costs that exceed 7.5 percent of your adjusted gross income as of 2012. Even if your withdrawal meets the exception requirements, you still have to pay income tax on the amount.
Age 70 1/2 Rule
When you turn 70 1/2, you must start taking distributions from your traditional IRA. These required minimum distributions are calculated by dividing your account's end-of-year balance by the figure on an IRS life-expectancy table that corresponds to your age. If you fail to withdraw the total required minimum distribution by Dec. 31 of any given year, the IRS will assess a 50 percent penalty on the amount you should have had taken but did not. You can petition the IRS for a waiver of the penalty by sending an explanatory letter to the agency.
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