A Roth or traditional Individual Retirement Account (IRA) can be a great boost to your retirement planning. IRAs are types of tax-advantaged accounts with rules established by the Internal Revenue Service (IRS). Traditional IRAs allow you to take a tax deduction for your contributions, while Roth IRAs provide you with tax-free withdrawals.
IRAs are not financial products, although they are administered by financial institutions like banks and brokerage firms. Unlike a bond or CD, it is not correct to say that an IRA matures. An IRA is an account in which you can place bonds or CDs, in addition to stocks, mutual funds, precious metals and even real estate. Interest you collect on IRA assets is tax-free as long as it remains in the account.
IRS rules allow you to make an annual contribution to your IRAs. As of 2010, your total IRA contributions cannot exceed $5,000 if you are under 50, and $6,000 if you are 50 or older. If you have a traditional IRA, you may be allowed to deduct your contribution--it depends on whether you are covered by a retirement plan at work, and if so, how much you make. You do not get a deduction for Roth IRA contributions, but qualified distributions (withdrawals) are tax-free.
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You can open and begin contributing to a Roth IRA any time; you have until the year you turn 70 1/2 to contribute to a traditional IRA. The year you turn 59 1/2, you can start taking penalty-free distributions from your IRAs. If you have a traditional IRA, you are required to take distributions from your account the year you turn 70 1/2 or pay a 50 percent penalty on the amount you should have withdrawn. Roth IRAs do not require you to make withdrawals.
You may have to pay a 10 percent penalty on funds you withdraw before you turn 59 1/2. If you have a traditional IRA, the entire amount of your distribution would be subject to a 10 percent penalty plus income taxes. If you have a Roth IRA, the 10 percent applies to only withdrawals you take from earnings your account accrued, rather than the amount of your contributions. You do not have to pay income taxes on earnings if your account has been open for at least five years.
IRAs are intended to help people save for retirement, and therefore the government imposes a tax penalty to make IRA owners think twice before raiding their accounts. However, if you need your IRA savings before you turn 59 1/2, you may qualify for a penalty exception. If you use an IRA distribution to pay for your first home or college expenses, or if you become disabled, you can take penalty-free withdrawals.