IRA Basics

• Anyone earning money can open a traditional IRA account. Unlike a Roth IRA, a traditional IRA has no income limits. The IRS allows individuals to set aside up $5,000 per year in an IRA. The limit rises to $6,000 annually at age 50 and older. Traditional IRA contributions reduce your taxable income. You can invest in mutual funds, stocks, certificates of deposit and money market instruments.
  
  

Distributions

• Distributions from your IRA are either qualified or nonqualified and are taxed at ordinary income tax rates. A nonqualified distribution is a withdrawal from your IRA account before the minimum age of 59 1/2. The IRS allows exceptions, such as taking money from your IRA to pay for medical expenses exceeding 7.5 percent of your adjusted gross income for the year. Otherwise, the IRS assesses a 10 percent early withdrawal fee. Qualified distributions count as income subject to ordinary income rates.
  
  

Required Minimum Distribution

• You don't have to take money from your IRA until 70 1/2 when the IRS mandates that you take a required minimum distribution, or RMD. You must take a distribution at 70 1/2 whether you are retired or not. The IRS calculates the RMD by dividing the end-of-year balance of your IRA by a life expectancy factor which it publishes every year. For example, if the balance of your IRA is $150,000 at December 31, 2010, and you turned 70 1/2 in 2011, divide your IRA balance by a factor of 27.4 to obtain a RMD of $5,474.45. The IRS uses 70 as your age even though you are 70 1/2. If you are married and your spouse is 10 years younger than you are, the RMD will be less. The RMD is taxed at ordinary income tax rates.
  
  

Required Minimum Distribution Penalty

• Failing to take the RMD triggers an excess accumulation tax. The IRS assesses a 50 percent penalty of the RMD amount. The IRS waives the penalty if the distribution shortfall was due to "reasonable" error. In this case, file Form 5329, although you must pay the penalty. If the IRS agrees with your explanation, it will refund the money.