How IRAs work by John Mussi

Are you taking advantage of individual retirement account (IRA) opportunities? IRAs can be frustrating because of the different forms and reports, difficult or confusing IRA rules. Successful retirement planning usually means coordinating personal savings with benefits from an employer’s retirement plan and social security. However, in the last 30 years, retirement planning has changed, putting more emphasis on personal saving through retirement plans at work and through IRAs.

IRA Owner Benefits

As additional incentives to save, IRAs provide current tax benefits, such as:

Tax-deductible contributions to eligible individuals of traditional IRAs (since 1975)

Nontaxable distributions from Roth IRAs (starting in 1998) are found to be a more attractive alternative by many individuals who are ineligible for traditional IRA deductions

Income tax deferral on IRA earnings enjoyed by both traditional IRA and Roth IRA owners

Although tax benefits are important savings incentives, IRA owners also enjoy these advantages:

IRA distributions are generally available at any time (though there may be a penalty for withdrawal before age 60)

IRA investment options are nearly limitless

IRA assets are eligible for a tax-free transfer between financial organizations

Contributions and Distributions

You invest money in an IRA, up to the amounts allowable under the tax law. These investments are termed “contributions.” In many instances an income tax deduction is available for the tax year for which the funds are contributed. The contributions, as well as the earnings and gains from these contributions, accumulate tax-free until you withdraw the money from the account. You therefore enjoy the ability to generate additional earnings, unreduced by taxes on these earnings, each year the funds remain within the IRA.

The withdrawals of the funds from the IRA are termed “distributions.” Distributions are subject to income taxation, generally in the year in which you receive them. Remember that in most cases you received an income tax deduction when you contributed the money to the IRA.

When You Can Cash In Your IRA

Since the original purpose of the IRA is to assist you in providing for your own retirement, it is not to your advantage to withdraw funds from an IRA before age 60. This disincentive takes the form of a 10 % tax “penalty” of the distributions received by you prior to age 60, unless certain exceptions apply. Given the complexity of this issue alone, professional advice should be obtained whenever significant amounts of distributions are needed. The fact is that many times the penalty can be avoided with proper planning. Obviously these distributions are subject to income taxation upon receipt. Once you are age 60 this “Premature Distribution” penalty is no longer applicable.

On the flip side of the government not wanting you to withdraw your money at too young an age, it also has rules to prevent you from not withdrawing the money soon enough. This is done in order that the government can tax it. You usually need to begin taking money from your IRA no later than April 1 of the calendar year following the date you attained age 70 1/2. The rules established by the government regarding these Required Minimum Distributions, their timing, the amounts, the recalculations, and the effect various beneficiary designations have on them, are among the most complex of the Internal Revenue Code. The penalty is 50 % of the shortfall between what you should have withdrawn and the amounts you actually withdrew by the proper date. This punitive penalty is matched only by the civil fraud penalty in severity. The necessary calculations are therefore not something that most individuals should attempt on their own.

You may freely reprint this article provided the following author’s biography (including the live URL link) remains intact:

About The Author

John Mussi is the founder of Direct Online Loans who help homeowners find the best available loans via the www.directonlineloans.co.uk website.