- Corporate sponsored retirement programs are nothing new in the United States. They date back to the latter half of the 19th century. Tax-advantaged individual retirement programs are a more recent development. Congress authorized the first individual retirement accounts in 1974 with the passage of the Employee Retirement Income Security Act. This act permitted self-employed workers, and those who worked for companies that did not offer a qualified retirement program, with a means of setting some funds aside in a tax-deferred account. Subsequent legislation extended these types of retirement accounts to most workers, regardless of their employment situation.
- There are two primary types of individual retirement accounts, including traditional IRAs and Roth IRAs. Contributions made to a traditional IRA are tax deductible for the tax year in which they are made, and the funds inside the account are allowed to grow tax deferred. The account holder pays ordinary income tax on funds from the account in the year they are withdrawn. Contributions made to a Roth IRA are not tax deductible, but the funds inside the account are allowed to grow tax free. The account holder does not pay any income tax on these funds when they are withdrawn.
- Funds can be withdrawn from a traditional IRA at any time. The account holder pays ordinary income taxes on all funds withdrawn from her IRA account. IRAs are intended to be long-term investments for retirement purposes, and since these accounts are tax advantaged the IRS charges a significant tax penalty of 10 percent of any funds that are withdrawn before the account holder reaches the age of 59 1/2 years. Qualified withdrawals can be made from Roth IRAs without any tax obligation after the funds have been in the account for at least five years and the account holder is at least 59 1/2 years old. Withdrawals made prior to this time are subject to a 10 percent tax penalty.
- Traditional IRA account owners are required to begin taking distributions from their retirement account once they reach 70 1/2 years of age. If the account holder does not take the required distribution he will be charged a 50 percent excise tax on the amount not distributed. There is no requirement to start taking distributions from a Roth IRA at any age.
- There are some instances which allow IRA account holders to take early withdrawals from their accounts without incurring a tax penalty. Traditional IRA holders who have not yet reached age 59 1/2 may take withdrawals to meet certain medical expenses, to pay for expenses associated with higher education, if they become disabled or to purchase a first home. Reasons for taking an early withdrawal from a Roth without incurring the tax penalty include disability, significant medical expenses, to pay health insurance premiums after becoming unemployed, to pay for higher education and disaster relief.
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