IRA's Limits And Penalties

IRAs are a great financial vehicle for saving money towards your retirement. The younger you are when you start contributing to an IRA the more your money will grow just by the fact of compounding interest and the deferring of taxes and or interest received.

However there are some restrictions you need to be aware of because unless certain circumstances exist, the money in your IRA cannot be taken out until you have reached 59 ½ years of age.

The purpose and the function of an IRA is to help supplement your social security income which is a government funded retirement account paid for by you and your employer's taxes.

For a Roth IRA the taxes are paid when you are putting in the money so that when you start to make withdrawals, the earnings it made are completely tax-free. The Traditional IRA the principal and the earning are only tax deferred and taxes are paid when you start to withdraw the funds.

To give an example how powerful this is; suppose that at age 26 you put $2,000 each year for forty years into a Roth IRA at 8% interest. By the end of forty years you would have put in $80,000 which you already paid the taxes on but because of compounding the interest you would now have $893,700 in your account which when you start withdrawing money from it is tax free.

Now to understand the distribution difference between the two type of IRAs is when you reach the age of 59 ½ you are eligible to either take out monthly payments or the whole amount. On the Traditional IRA you must then pay income tax on the entire distribution amount. That's principal and interest while with the Roth your money grew tax-free so no matter how much you take out you pay no income taxes on it. Also understand that in either IRA if you just take out monthly payments instead of the whole fund, your fund will still grow with compounded interest.

Now with the Traditional IRA you can take your money out at any time but you will pay a 10% penalty and income taxes on the amount you withdraw. The Roth IRA you will pay the 10% penalty but the principal will not be taxed again. It isn't wise to take your money out early but sometimes certain financial hardships make this an option that you need to choose. Now with certain types of hardships, there are some exceptions to the 10% penalty.

One exception to avoid the penalty is for a first time purchase of a home or to build one. Also if you incurred medical expenses that exceeded 7.5% of your annual income you could take a distribution equaling the medical expenses and avoid the penalty. One other exception is you could take the money out early to avoid an eviction or a foreclosure.

The reason for these penalties are to discourage investors for trying to use their IRA as a short term gain to invest in something a bit more aggressive for short term gain that wasn't devised for retirement income. The exceptions were created to help those that truly fall on financial rough times.


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Casey Trillbar is the editor of YourRothIRAGuide.com, which is a website aimed at supplying articles, information and resources to people considering the use of a Roth IRA Agreement for their retirement. http://www.YourRothIRAGuide.com