An individual retirement account is a special, tax-advantaged, trustee-based account where you can set aside a portion of your earned income toward your retirement years. There are two primary types of individual retirement accounts; traditional IRAs and Roth IRAs. Both types of accounts offer some similar, and some significantly different, tax benefits, including how your withdrawals are taxed.
Traditional vs Roth
The primary difference between a traditional individual retirement account and a Roth IRA involves when you pay your taxes. Earnings in both types of accounts are allowed to grow tax-deferred until you withdraw them. Contributions to a traditional IRA are made with pre-tax dollars, so all withdrawals are taxed as ordinary income. Contributions to a Roth IRA are made with after-tax dollars. Since you have already paid taxes on these funds, qualified withdrawals can be made tax-free.
Traditional IRA Mandatory Withdrawals
You must begin taking mandatory withdrawals from your traditional individual retirement account once you reach 70 1/2 years of age, as of the time of publication, according to the Internal Revenue Service. Withdrawals will be treated as ordinary income and taxed at your then current tax rate. There is no requirement to take your withdrawals in any particular form. You may sell any investments you have in your traditional IRA and take your withdrawals in cash, or you may request the custodian of your IRA account to do a direct transfer of your IRA assets into a taxable account. It is possible to take your mandatory withdrawals in cash and leave your stock in your traditional IRA for a time, but eventually you will have to liquidate your stock or transfer your stock to a taxable account to comply with the IRS's mandatory withdrawal schedule.
Roth IRA Withdrawals
There is no requirement to take mandatory withdrawals from your Roth individual retirement account, regardless of your age. You can keep assets in your Roth IRA in a variety of forms, including cash, mutual funds, individual stocks, bonds, investment trusts and many others. You may withdraw the cash portion from your Roth IRA and leave your other investments, including stocks, inside your Roth IRA where they can continue to grow tax-deferred.
Any withdrawal from a traditional IRA, regardless of whether it is taken in cash or in the form of a direct transfer of assets into a taxable account, will be taxed as ordinary income at your then current tax rate. If you withdraw fund prior to reaching age 59 1/2 the IRS will additionally charge your a tax penalty of 10 percent of the amount withdrawn. You can withdraw an amount equal to your contributions to your Roth IRA at any time without paying income taxes, since you have already paid your taxes on those funds. Any earnings generated in your Roth IRA must remain in your account for at least five years to qualify for tax-free withdrawal. You can start making qualified withdrawals from your Roth IRA once you reach age 59 1/2. If you take earnings before you reach age 59 1/2, or before the earnings have been in your Roth account for at least five years regardless of your age, the earnings will be taxed as ordinary income and the IRS will charge a 10 percent tax penalty on the non-qualified amount.
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