When Do You Have to Draw Money Out of Your IRA?
Investors generally use Individual Retirement Accounts (IRAs) to fund retirement. The two main types of IRAs -- traditional and Roth IRAs -- offer their own unique tax benefits. Depending upon the type of IRA you have and your age, you might need to draw money out of your IRA account or face a stiff penalty from the IRS.
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Types
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To understand how IRAs work, investors should be able to differentiate between the two main types. With a traditional IRA, the IRS gives account holders an up-front tax benefit. Investors can deduct contributions made to a traditional IRA, up to an annual limit, from their taxable income. The IRS provides a back-end tax perk with Roth IRAs. Investors do not receive a tax deduction, however, as long as the account has been held for five years and the account holder has reached 59 and 1/2 years of age, all Roth IRA withdrawals, including earnings, come out tax-free, according to IRS Publication 590. Both types of accounts offer tax-deferred growth, which means that investors do not have to pay taxes on earnings, such as dividends and capital gains, yearly.
Required Minimum Distribution
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The IRS does not require investors to withdraw Roth IRA money -- ever. With a traditional IRA, however, account holders must begin withdrawing money from their IRA by April 1st of the year after they turn 70 1/2 years of age. For example, if an individual turns 70 1/2 in 2010, he has until April 1, 2011, to begin taking what IRS Publication 590 refers to as his "Required Minimum Distribution (RMD)." An IRA investor's age, account value and life expectancy dictates the amount of his RMD.
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Function
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Since the government defers income tax on traditional IRA contributions, it wants to get its hands on its share of an investor's money before she dies. By requiring traditional IRA account holders to take RMDs, the IRS ensures that it receives at least some tax revenue on traditional IRA monies.
Warning
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If an investor fails to take an RMD or takes a smaller RMD than he was supposed to take, the IRS takes relatively severe action. As IRS Publication 590 explains, the IRS levies a 50 percent excise tax "on the amount not distributed." If an investor fails to take an RMD in a given year, he faces a 50 percent tax on the entire amount in addition to regular income taxes due on the RMD, which the IRS effectively forces him to take.
Considerations
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Because of the stock market crash of 2008-09, the federal government suspended RMDs for 2009 in the Worker, Retiree, and Employer Recovery Act of 2008. Congress's rationale is that investors should not be forced to take money out of IRA accounts that lost significant value. As of October 2010, the IRS plans to continue the RMD stipulation in 2010 and beyond.
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