Before you make an IRA investment, plan ahead. Determine when you will need to make any IRA withdrawals. Decide if you will need a tax deduction.
Review all the rules and regulations of the Traditional IRA and the Roth IRA to determine which one best fits your investment needs. Each type of Individual Retirement Account offers the investor different features.
Roth IRA Account:
- Your Roth IRA contributions are not tax-deductible.
- If you need to make any IRA withdrawals before age 59 1/2, a Roth IRA may be better than a Traditional IRA.
- Direct contributions to a Roth IRA account can be withdrawn tax-free and penalty free at any time for any reason.
- Rollover or converted amounts are handled differently.
- Converted amounts to a Roth IRA can be withdrawn tax-free and without penalties after the account is 5 years old.
- So you can make tax-free and penalty free withdrawals before you turn age 59 1/2 after the account is over 5 years old.
- With converted amounts you can also avoid paying early withdrawal penalties, by meeting one of the following exceptions.
Exceptions to 10% Tax Penalty for Roth IRA’s
- You have reached age 59 1/2.
- You are disabled.
- You are the beneficiary of a deceased IRA owner.
- You use the IRA distribution as a first-time home buyer.
- You pay for unreimbursed medical expenses.
- You pay for medical insurance after losing your job.
- You pay for higher education expenses.
- Depending on your Adjusted Gross Income, and whether or not you contribute to a 401k plan or other retirement plan, your IRA contribution may be tax-deductible.
- Contributions and the earnings on the IRA account are taxed as ordinary income at withdrawal.
- Withdrawals may begin after age 59 1/2.
- Withdrawals are mandatory at age 70 1/2.
- Minimum distributions must begin once you reach age 70 1/2.
- If you fail to make your minimum distribution after reaching age 70 1/2, you will pay a 50 % penalty.
- The penalty is on the difference between what you should have withdrawn and what you did withdraw.
- IRA withdrawals from a Traditional IRA account before age 59 1/2 are taxable as ordinary income.
- Withdrawals before age 59 1/2 are also subject to a 10% early withdrawal penalty.
- There are 6 exceptions to the 10% early withdrawal penalty. If you meet one of the 6 qualifications, you can make an IRA withdrawal and avoid paying the 10% early withdrawal tax.
- You will not however avoid paying ordinary income tax on an early withdrawal.
Exceptions to 10% Tax Penalty for Traditional IRA’s
- Payment of unreimbursed medical expenses.
- Payment of medical insurance premiums due to job loss.
- First-time home buyer expense.
- Higher education expense.
When in doubt – check it out. Since there are different rules for each type of IRA account it pays to learn the differences. Ask your tax advisor or financial planner for additional clarity.