Understanding the IRA Rules
A lot has been written about IRA rules already, however, this article attempts to simplify the complexity of the program.
IRA stands for Individual Retirement Account, a personal savings account used to help ensure sufficient finances for every contributing person when he retires. When I say “contributing person”, it means he or she who is setting aside funds out from his taxable earnings during the year whether it be from his/her wage, salary, a bonus, or accumulated service tips.
Kinds of IRA
There are presently three kinds of IRAs:
- Roth IRA
- The Simple IRA
Although all pertain to retirement savings account, there are however, slight differences in terms of rules of Eligibility, Contribution, and Withdrawal.
In terms of eligibility, anyone receiving some form of compensation is permitted to make contributions for IRA. While Roth IRA does not set an age limit, the traditional type, on the other hand, sets less than 70 and a half. As for a Simple IRA, only those who have been receiving or earning more than $5000 for the past 2 years until the present qualify for the program.
Roth and Traditional IRAs are mostly the same in terms of how much contribution a person can make. One can make up to $5000 worth of contribution if he is 49 years old or less. Person’s aging 50 years and above, may catch up his or her contribution by adding $1000.
For a person with a Simple IRA plan, the contribution limit can reach up to $11,500. A $2500 catch-up contribution is allowable for people with the same IRA plan and aging 50 years beyond.
Note that these figures are true only in accordance to the published standards for year 2010. Contribution limits may increase in time due to inflation.
All of the IRA withdrawal rules regardless of the type of IRA may begin when the contributor reaches the age of 59 and a half. Any withdrawal done earlier than this will be liable for a 10% penalty tax unless the reason of withdrawal falls in one of the valid exceptions e.g. disability, first-time homeowner, and others (see the 10% tax exemptions).
To distinctly identify one IRA type from another in terms of withdrawal, the following differences mark it.
Traditional IRAs introduced MRD, Minimum Required Distributions, for people who reaches the age of 70 and a half. This is primarily for the purpose of ensuring that the remaining distributions are withdrawn methodically by the contributor to suffice what he assumingly needs until he reaches the end of his lifespan. Distributions should be taken on the 1st of April, the year after he or she turns 70 ½. Any unclaimed distribution can be withdrawn on December 31st of the same year.
Roth IRA, on the other hand, does not impose MRD. Also 10% penalty tax for this IRA type is only applicable when the contributor withdraws before the expiration of his 5 taxable year period which commences at the time the first contribution has been made.
Lastly, Simple IRA follows the same withdrawal guidelines as with the Traditional IRA except for a unique “2-year period rule”. This means that if the employer, who is the source of the employee’s IRA fund, takes an early distribution within the 2-year period (starting at the time the employer made the first contribution), such will be subject to a 25% penalty tax instead of 10%.
Just to reiterate the IRA basics, all details relating to penalty taxes apply only when the withdrawal reason does not fall in any of the published exceptions – some of which have been aforementioned.