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Feature Articles: Financial Information & Tips

 

IRA Distribution FormIndividual Retirement Account (IRA)

 

An Individual Retirement Account (IRA) is a retirement savings vehicle with tax benefits. Individuals purchase IRAs from financial institutions, investment companies, mutual funds or brokerage firms.

 

Types of IRAs

 

Traditional

  • Individual IRAs — This type of IRA has been available since 1974. Congress created individual IRAs to provide incentives for people to save for retirement. An individual can contribute up to $2,000 of income per year. You do not pay taxes on the IRA contributions until money is withdrawn.
  • Spouse IRAs — If your spouse has no income, you may still open a second IRA in your spouse’s name and contribute up to $2,000 per year. Contributions to the two IRAs together cannot exceed $4,000 a year.

 

Roth IRAs

In 1997, the Tax Payer Relief Act created a new type of IRA called a Roth IRA. You contribute to a Roth IRA with after-tax dollars (income you have already paid taxes on), but all withdrawals after the age of 59 are tax-free unless the withdrawal is made before the owner is age 59 or before the IRA has been held for at least five years. Taking withdrawals from a Roth IRA before age 59 or before the Roth has been held for five years usually results in tax penalties.

 

Tax implications

 

Congress intended IRAs to be a retirement savings account, so any money withdrawn before age 59 may be subject to a 10 percent excise tax. Not only do you lose 10 percent of the money you withdraw to taxes, you may have to pay withdrawal fees. You will also need to report the money withdrawn from the IRA as part of your taxable income for the year.

 

There are some exceptions to the 10 percent excise tax or early distribution penalty.

 

  • If you die, any withdrawals from your IRA will not incur an early distribution penalty.
  • If you become disabled, no withdrawals from your IRA will incur an early distribution penalty.
  • If you withdraw the money for a medical expense and the medical expense is greater than 7.5 percent of your adjusted gross income, you do not have to pay the early distribution penalty.
  • If you become unemployed and you withdraw the money to pay for health insurance premiums for yourself or your family members, you do not have to pay the early distribution fee.
  • If you are buying your first home, you may withdraw money without paying the early distribution fee, as long as you use the funds within 120 days of withdrawal for qualified costs associated with the purchase of your first home. See irs.gov for information about which costs qualify.
  • If you withdraw money in order to pay for higher education or college expenses for yourself or a dependent, you may withdraw the money without paying the early distribution fee.
  • If the withdrawals are part of a series of equal withdrawals over the life of the IRA owner in the form of an annuity (based on life expectancy) than you do not have to pay the early distribution fee.
  • If you are a qualified reservist, you do not have to pay the early distribution fee.

 

Keep in mind, even if you qualify for an exemption from the 10 percent early distribution fee, you still have to report the amount withdrawn as part of your yearly income and pay any and all taxes associated with it. Similar rules apply to 401(k) and other qualified retirement plans.

 

See IRS Publication 590 for more detailed information about early IRA and Roth IRA distributions. Similar penalties and exceptions apply to 401(k) and other qualified retirement plans. See IRS Publication 575 for more detailed information about non-IRA plans. These publications can be found on the IRS website.

 

Adapted from Montana State University Extension Service (September 2003). Withdrawals from IRAs when the owner is under age 59½. MontGuide MT200308 HR. Bozeman, MT: MSU Extension Service

 


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Last update: Monday, October 31, 2011