When you contribute to an IRA, the money, plus any earnings, is not taxed as long as you leave the funds in the account. You don’t need to start taking money out until you are 70 1/2 years old and not even then if it is a Roth IRA. Once you reach retirement age, it’s OK to withdraw money you need. However, there are some advantages to leaving money in an IRA as long as possible.
The 59 1/2 Rule
Legally, you may take money out of an IRA anytime. However, IRAs are retirement accounts and you receive tax benefits with the understanding you will wait until you are 59 1/2 years old before taking distributions from an IRA. For Roth IRAs only, there is an additional rule. A Roth IRA account must be at least five calendar years old before any funds are withdrawn. If you don’t follow these rules, you’ll lose any tax benefits and may have to pay a 10 percent penalty tax as well.
When you withdraw money from a traditional IRA after you reach age 59 1/2, the funds are taxed as ordinary income for the year in which the withdrawal takes place. If the balance in the IRA is large, you probably don’t want to take it out all at once. That’s because a big withdrawal may push you into a high tax bracket, causing the money to be taxed at a high percentage rate. For example, suppose your other income puts you in the 15 percent tax bracket. Much of a large distribution from a traditional IRA could then fall in the 25 percent bracket, so you’d pay an extra 10 percent you wouldn’t owe if you spread withdrawals out over several years.
Once a Roth IRA is at least five years old and you are 59 1/2 years old, any distribution is considered to be qualified by the IRS. You can withdraw any amount of money from the account and it will not be subject to income taxes. If the account is not five years old, you lose this tax benefit. The money withdrawn will be taxed as ordinary income. You’ll have to pay a 10 percent penalty tax as well unless the reason for the withdrawal meets IRS requirements as an exception to the penalty tax.
Because money in an IRA is not taxed until withdrawn, there’s a distinct advantage to leaving it in the account. Since you aren’t paying taxes, earnings grow faster. In addition, for Roth IRAs those earnings will be tax-exempt when you eventually take them out. Once you withdraw funds from any IRA, you get no further tax benefits. If you want to use the money as retirement income, this may not matter. However, if you reinvest any money taken from an IRA, the earnings from such investments won’t enjoy the IRA tax benefits.