Are there different types of individual retirement accounts?
Yes, there are two distinct types of individual retirement accounts, and there are some hybrids. The two most commonly used IRAs are the Roth IRA and the traditional individual retirement account.
How does taxation work with traditional individual retirement accounts?
With a traditional account, you make contributions before you pay taxes on the income, so you get a tax break every year. On the other side of the coin, when you take distributions, they are taxable.
How about Roth IRA taxation?
This is the core difference between the two types of accounts. A Roth individual retirement account is funded with after-tax earnings, so distributions are not subject to taxation.
When can you take distributions?
You can take distributions at any time, but there is a 10 percent penalty. This applies to all of the assets in a traditional account. There is no penalty for Roth account holders if they remove portions of the contributions, but the penalty is applicable if the earnings are withdrawn.
When can you accept penalty-free distributions?
For both types of accounts, you can accept distributions without being penalized when you are 59.5 years of age.
Are there any exceptions to the early withdrawal rule?
Yes, there are a number of exceptions. You can take money out of an individual retirement account to cover unpaid medical expenses, and you can use the funds to pay higher education tuition. If you are unemployed, you can accept distributions to cover your health insurance premiums. An account holder may also withdraw up to $10,000 to apply to a first home purchase.
Can you leave the money in your account indefinitely if you never need it?
The answer is yes and no. If you have a traditional individual retirement account, you are compelled to take required minimum distributions (RMDs) when you are 72 years of age. This age was 70.5, but it was increased when the SECURE Act was enacted at the end of 2019. The RMD requirement is in place because the IRS wants to start getting some tax dollars while the account holder is still alive. Roth account holders do not have to accept required minimum distributions, because they have already paid taxes on the contributions.
Are you allowed to contribute into your account with no age limit?
This is a good question because the answer has recently changed. Another provision that is contained within the SECURE Act gave traditional account holders the ability to contribute into their accounts for any length of time. In the past, contributions had to cease when account holders reached the required minimum distribution age. Roth account holders have always been allowed to contribute into their accounts indefinitely.
What are the rules for individual retirement account beneficiaries?
A beneficiary that is the spouse of the decedent can roll the account into their own account or retitle it as an inherited account. Non-spouse beneficiaries do not have the rollover option. They are required to take mandatory distributions on an annual basis that are based on the age of the beneficiary and the balance in the account. Distributions to traditional account holders are taxable, and Roth account beneficiaries receive distributions tax-free. Prior to the enactment of the SECURE Act, the “stretch IRA” strategy was recommended by estate planning attorneys. The idea was to take only the minimum that was required by law for the maximum length of time in an effort to fully capitalize on the tax benefits. This approach was particularly fruitful for relatively young beneficiaries of well-funded Roth accounts, because the distributions would be tax-free. Now, all of the assets must be cleared out of an inherited account within 10 years of the time of acquisition.