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One of the most common methods used by individuals to save money for retirement is the individual retirement account (IRA). The U.S. government has offered incentives through the tax code for the use of IRAs, making them a valuable tool for accumulating retirement savings. When a person stops putting money into an IRA and begins to withdraw money from it, these withdrawals are called IRA distributions. With a traditional IRA, a periodic IRA distribution can be taken, free of any penalties, once the account owner reaches the age of 59.5 years.
An IRA distribution can actually be taken at any time, though a penalty usually applies if this is done too early. Eventual withdrawal from an IRA is considered taxable income, but this does not mean that a certain amount of taxes cannot be avoided, using an IRA. For example, a person may contribute a large portion of their yearly income to an IRA, up to a certain dollar amount. These contributions can be made with pre-tax funds, meaning that a person could potentially put himself in a lower income tax bracket by contributing to his IRA.
In the above case, a person will then usually retire at a given age and begin to withdraw from his IRA. His IRA distribution is considered taxable income, but his distribution likely will be lower than his income was while he was working. This will once again place him in a relatively low tax bracket, especially if his IRA distribution represents a large percentage of his income. This will all have the effect of saving that person a large amount of money in taxes, over the course of his lifetime.
A person may take an IRA distribution, penalty-free, once he reaches 59.5 years of age. Also, that person must begin taking a distribution by 1 April of the year in which he reaches 70.5 years of age. At that point, a certain minimum amount called the Required Minimum Distribution must be withdrawn, according to tax law.
This is all true in the case of most IRAs. A Roth IRA, on the other hand, has fewer restrictions on what can and cannot be done with the money once it is in the account. It is worth noting, though, that contributions to a Roth IRA must be made with after-tax dollars.
Certain situations exist in which a person may take an IRA distribution before it would normally be permitted. These exceptions include withdrawals to pay for medical insurance while a person is unemployed, and certain qualified educational expenses. IRAs also offer a little-known additional benefit: IRA funds are protected in the event that the account owner becomes a debtor in a bankruptcy proceeding.