As you approach retirement or if you are already retired, you may have retirement money stashed away in individual retirement accounts (IRAs). IRA money typically comes from two sources:
- Money you contribute to a traditional IRA or a Roth IRA. With a traditional IRA, you may receive a tax break when you put money in the traditional IRA (i.e., the ability to subtract your savings contribution from the income that you report on your federal income tax return). With a Roth IRA, you don’t receive a tax break until you take money out of your Roth IRA (i.e., the ability to make tax-free withdrawals after age 59½ if an account is open at least five years).
- Retirement plan money from a former employer that you’ve invested in a Rollover IRA. Any time you’ve changed jobs and had retirement plan money available from a former employer, it generally is a good idea to roll that money into an IRA. Doing so prevents you from having to pay taxes at that time, and it allows that money to continue growing on a tax-deferred basis.
Taking Money Out of Your IRA
When you want to start taking money out of your IRAs, it’s a good idea to know how the rules work. There basically are two scenarios, depending on the type of IRA you own.
- Roth IRAs. If you are over 59½ and have owned a Roth IRA for at least five years, you can take any amount of money out of your Roth IRA without having to pay any income taxes or penalties.
- Other IRAs. If you own a traditional IRA or a rollover IRA and are over 59½, then typically any money you take out of these IRAs will be taxable to you as ordinary income.
What If You Retire Early?
What if you’re under 59½ and would like to or need to retire early? Normally a 10 percent early withdrawal penalty applies to money taken out of retirement accounts before age 59½. But there are a few exceptions such as death, disability, qualified first time home purchases and qualified education expenses; see your tax advisor or financial planner for details. Even if you do avoid the 10 percent penalty, remember that your retirement money likely will still be taxed as income to you.