IRA Income: Must know tax rules relating to your IRA

We should all be saving for retirement. An individual retirement arrangement (IRA) can be a great method to do so. IRAs allow you to save for retirement while also providing tax benefits. In order to fully take advantage of the retirement account, you should know the important tax rules surrounding your IRA. Knowing the rules will help you in your IRA decision-making, including how to take advantage of the tax benefits, and how to avoid the tax penalties.

In general, you cannot make withdrawals from your IRA until you reach the age of 59 1/2. The mandatory age to start withdrawals is 70 1/2. By following the age requirements, you will avoid the tax penalty on early withdrawals. The tax rules relating to IRA distributions (withdrawals) vary based on several factors.

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Taxation of IRA Distributions

As stated, you are eligible for distributions at age 59 and required for distributions at age 70. The type of IRA determines if the distributions received are taxable or nontaxable.

Traditional IRA

When you receive a distribution from a traditional IRA, the entire distribution amount is taxable as ordinary income. You will pay taxes on the withdrawal at ordinary rates.This applies to distributions of principal and distributions of earnings.

Roth IRA

When you receive a distribution from a Roth IRA, the entire distribution is nontaxable. You will not pay any taxes on the withdrawal.

Early Withdrawal Tax Penalty

Circumstances in life may require you to withdraw money early from your retirement savings account. If you withdraw money early from your IRA, you will face a 10% penalty tax on the distribution amount. Please note that the 10% penalty tax is on top of your ordinary income tax. Because of the penalty, it is best to avoid the early withdrawal penalty. However, some exceptions to the penalty tax exist.

Exceptions to avoid the IRA early withdrawal tax penalty

Homebuyer
You will not face the early withdrawal tax penalty when the distribution is used to purchase your first home. The maxium distribution exclusion is $10,000. Additionally, you must use the distribution within 120 days. Again, this exeption only applies to first time homebuyers.

Education expenses
You will not face the early withdrawal tax penalty when the distribution is used for qualified educational expenses. Qualified education expenses include college tuition, fees, and books.

Unreimbursed medical expenses
You will not face the early withdrawal tax penalty when the distribution is used to cover non-reimbursed medical expenses in excess of 10% of your AGI.

Disability
You will not face the early withdrawal tax penalty when you become permanently or indefinitely disabled during the year.

Medical Insurance
You will not face the early withdrawal tax penalty when the distribution is used to cover insurance. You qualify for this exception if you qualify for unemployment compensation for 12 consecutive weeks.

Death
The death of the IRA owner eliminates the early withdrawal tax penalty.

In conclusion

IRAs serve as great tools for retirement investing. Knowing and understanding the tax rules and tax benefits will allow you to fully take advantage of your retirement savings account. The main rule focuses on the age requirement for distributions. As stated, early withdrawals should be avoided due to the 10% tax penalty; however, several exceptions to the rule exist. Know the common exceptions stated above.

I hope you furthered your understanding about the tax rules surrounding your IRA. Remember to follow the tax rules to better manage your retirement savings investment. Please share with others to help them learn about IRA tax rules.

Please comment below if you have any questions related to IRA income.