Daily Deduction: Roth vs. Traditional IRAs

Now that we've considered how to put money into your IRA, let's think about how to get it out. There are two ways -- withdrawals and distributions. You make a withdrawal when you remove money from your account prior to your retirement. In contrast, you receive a distribution when your account trustee makes a payment to you after your retirement. These two things are taxed quite differently if you have a traditional IRA, and they generally aren't taxed at all if you have a Roth. Withdrawals from a traditional IRA can be painful under the wrong circumstances. In addition to paying tax on the money you receive, you may also have to pay a 10% penalty. The penalty applies to most withdrawals that you take before you reach the age of 59-1/2.

There are several exceptions though. You may avoid the penalty if you use the money for large, unreimbursed medical expenses, payments for medical insurance, higher education expenses, or to buy or build your first home. If any one of those exceptions apply to your withdrawal, you will still be taxed on the money that you receive, but you can avoid the 10% penalty.

Roth IRAs are much different. After you've had your account for five years, you can withdraw money from it tax free and penalty free. Of course, if you remove your money within five years of opening your account, you will be subject to the usual 10% penalty unless one of the above exceptions applies. Even if you pay the penalty, though, you still will not be taxed on your withdrawal. This no-tax rule makes Roth IRAs a good choice for people who want to save for retirement but who are afraid that they might need to use their savings for big, unanticipated expenses in the future.

Retirement Distributions