IRAs are retirement accounts in the US that offer tax benefits, but account holders over 70½ must make mandatory annual withdrawals or face a tax penalty. Roth IRAs, funded with after-tax earnings, do not require mandatory withdrawals and are tax-free.
In the United States, people can save money for their retirement years by making annual contributions to Individual Retirement Agreements (IRAs). For most types of IRAs, the IRS requires account holders age 70½ and older to begin making mandatory annual withdrawals. Anyone who fails to make the mandatory IRA withdrawal incurs a federal tax penalty.
IRAs are generally funded with pre-tax earnings. Account holders designate their contributions as IRA money but may invest their contributions in a variety of different investment vehicles, including stocks, bonds, and real estate. IRA accounts provide a tax shelter, which means the account holder does not pay taxes on contributions or earnings until withdrawals are made. The IRS enforces the IRA Mandatory Withdrawal Rule to prevent taxpayers from shielding money from taxes for a lifetime.
Required minimum distributions from IRAs are based on the life expectancy of the account owner or the joint life expectancy of the account owner and the account owner’s spouse. The IRS produces actuarial tables that account holders can use to determine the size of the mandatory IRA withdrawal they must make. These tables are based on statistical averages of life expectancy. Many people own multiple IRA accounts, in which case they must make a withdrawal based on their combined IRA balances. An account holder can withdraw money from just one IRA instead of taking withdrawals from every IRA he owns, as long as the total amount withdrawn meets the minimum required by the IRS.
For the first withdrawal, an account holder can make the mandatory IRA withdrawal any time between January 1 of the year in which they turn 70½ and April 1 of the following year. In subsequent years, withdrawals must be made between January 1 and December 31 of the same calendar year. Therefore, an IRA owner can make their first two annual withdrawals within the same calendar year. Anyone who does not take the annual withdrawal must pay a tax penalty equal to 50 percent of the required minimum distribution that he did not make.
Roth IRAs are a type of retirement account that is funded by after-tax earnings. Money deposited in a Roth IRA grows on a tax-sheltered basis in the same way other IRAs grow, so the account holder’s earnings are not taxed annually. Under federal tax laws, individuals do not have to make mandatory IRA withdrawals from Roth IRAs. Also, the IRS does not assess taxes on Roth withdrawals or Roth earnings.
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