What is an IRA?
An individual retirement account, or IRA, is the only kind of tax-advantaged retirement account that can be opened by virtually anyone. You can contribute up to $4,000 a year to an IRA ($5,000 in 2008), as long as you earn that much in a year or more. If you are age 50 or older, you could contribute an extra $1,000 beginning in 2006. The money you invest may or may not be tax deductible, depending on how much you earn and whether you are married. Regardless of whether you can deduct the contribution from your annual income tax bill, the money you put into the account will grow tax-free until you start making withdrawals. Most people wait until they are at least 59 1/2 before they begin pulling money out of their IRAs, because the Internal Revenue Service usually levies a 10% "early withdrawal" penalty on money withdrawn sooner.

What's the best type of financial institution to use for an IRA?
You can establish an individual retirement account (IRA) just about anywhere you wish. But before you open a new IRA account, first make sure you know which types of investments the financial institution allows its customers to make. Most investors establish their IRAs at a bank, brokerage firm, mutual fund company or insurance company. But while some of these institutions allow you to invest the money however you wish, others limit your selection or charge additional fees if you want to place money in something other than the types of investments offered through the financial institution itself.

What is a Roth IRA?
The Taxpayer Relief Act of 1997 created a new type of individual retirement account called a Roth IRA. The key feature of the Roth IRA is that, while contributions aren’t tax-deductible, the money you later withdraw is tax-free.
To qualify as a tax-free distribution, the withdrawal must be made at least five taxable years after the first contribution to the account was made. In addition, the distribution must meet at least one of the following conditions:
1) The withdrawal is made after the account-holder reaches age 59 1/2;
2) The money, $10,000 or less, is used to purchase a first home;
3) The withdrawal is made because the account-holder becomes disabled, or
4) The distribution is made to a beneficiary after the account-holder’s death.
It’s important to note that the tax law does not allow individuals to contribute more than $4,000 ($5,000 in 2008) to all of their individual IRAs (with the exception of contributions to an educational account). The only way to put a lot of money into any type of individual retirement account is to roll over money from an employer-sponsored 401(k) or similar account. For more information, see the Roth IRA section of IRS Publication 590, Individual Retirement Arrangements. You can download it from the IRS Web site, or order by calling 1-800-TAX-FORM (829-3676).

Can I establish a Roth IRA regardless of how much I make?
The Roth IRA, was created by the Taxpayer Relief Act of 1997. Contributions to a Roth IRA are not tax-deductible, but penalty-free withdrawals can be made if the taxpayer’s account has been open for at least five years, the taxpayer’s age is at least 59 1/2 or the withdrawal is used to purchase a first home. Because the new Roth IRA was primarily created to help low- and middle-income people save, the law restricts the ability of upper-income taxpayers to open such an account. A maximum of $5,000 a year in 2008 can be contributed to an account by single tax-filers with adjusted gross income (AGI) less than $101,000 and joint filers with combined income less than $159,000. The maximum contribution phases out for single filers with adjusted gross income between $101,000 and $116,000; and for joint filers, the phase-out affects those with AGI between $159,000 and $169,000.

How do I convert my current Individual Retirement Account into a new Roth IRA?
Generally, a taxpayer can convert his or her conventional IRA into a new Roth IRA if the taxpayer’s adjusted gross income is less than $100,000 (for both single and joint filers). Any amount that would have been taxable as income when withdrawn from the existing account will be taxed. To convert to a Roth IRA , you must complete a Roth IRA Adoption Agreement and a Roth Conversion form. Be certain to indicate on the Roth Conversion form whether taxes are to be withheld from the IRA funds or will be paid from another source. Once the Roth Conversion IRA has been established, assets in the ordinary IRA will be moved to the Roth Conversion IRA. If you do not wish to convert the entire amount, you must indicate on the conversion form the exact security description and the amount of cash that is to be moved from the ordinary IRA.

How do I use money saved in my Roth IRA to pay for college?
Certain expenses for education qualify as penalty-free distributions from a Roth IRA. This is important since the penalty for early distribution of a Roth IRA is 10 percent. Qualified expenses include college tuition, fees, books, supplies, and room and board. However, that portion of the distribution consisting of earnings on prior contributions will be taxable since distributions from a Roth IRA to pay for higher education expenses do not qualifiy as totally tax free unless the account is more than five years old and the owner has attained age 59 1/2. Contributions to a Roth IRA are not tax deductible, but the principal and interest grow tax-free. Annual contributions to a Roth IRA are currently limited to $4,000 in 2007 and $5,000 in 2008.

What is a SEP-IRA?
A simplified employee pension (SEP) plan is a retirement plan used by many people who run a small business. A SEP is actually a special type of individual retirement account (IRA). As a result, it’s often called a SEP-IRA.

Can I invest in both a SEP and a traditional IRA?
If you are participating in a simplified employee pension (SEP) plan, the Internal Revenue Service will allow you to save even more money for retirement by allowing you to set up a separate Individual Retirement Account (IRA). The money you contribute to the IRA may or may not be tax-deductible, depending on how much you earn and whether you’re married or not. But even if you can’t deduct the contribution on your income tax return, the investments inside the IRA will grow tax-deferred until you begin making withdrawals.

What is a spousal IRA?
The spousal IRA was created by the Tax Reform Act of 1997. It allows the husband or wife of a participant in a qualified retirement plan, such as a 401(k), to make a tax-deductible contribution to an IRA. In 2005, a couple can contribute and deduct up to $5,000 in 2008 on behalf of the spouse not enrolled in a retirement plan, even when that person earns little or no income. The deduction phases out for couples filing jointly who have between $159,000 and $169,000 of modified adjusted gross income.

What are the pros and cons of having large amounts of money in an IRA?
One of the biggest benefits of having an Individual Retirement Account (IRA) is that money in the account grows, tax-free, until you begin making withdrawals. The only trouble is, you can't really touch the money until you turn 59 1/2 unless you're willing to pay a stiff 10% penalty. So, in addition to having a retirement account to see you through your "golden years," also make sure you have other investments that can be quickly and easily tapped for cash while you're still young.

How much can I contribute to my Individual Retirement Account (IRA) in 2005 and beyond?
The contribution limit for Individual Retirement Accounts (IRAs) is $4,000 per year until 2008 when it will be $5,000 per year.

What are catch-up retirement contributions for individual age 50 and older?
Individuals age 50 and older can make additional catch-up contributions to their retirement accounts. They can contribute an additional $1,000 per year to an Individual Retirement Account (IRA). The contribution limits are also increased for other types of retirement plans.

Have the limits on the maximum amount that can be contributed to a spousal IRA changed?
In the waning days of the 1996 Congressional session, lawmakers approved a key change in the tax codes concerning Individual Retirement Accounts held by married couples. The change involves so-called "spousal" IRAs. Beginning in 2005, the Internal Revenue Service allows two-earner couples to each contribute to a retirement account. Families in which only one spouse worked can each contribute up to $4,000 a year in 2007 (and $5,000 in 2008) to individual accounts, regardless of whether only one spouse works or both of them do.

Is there a tax penalty if I contribute more than the maximum to my Individual Retirement Account (IRA)?
If you contribute more than the maximum allowable amount (including the catch-up amount), you will have to pay a penalty. If contributions (deductible or nondeductible) in excess of the amount allowed are made to an IRA, an excise tax equal to 6% of the excess contribution is imposed until the excess is withdrawn or used to reduce later years’ contributions. This penalty can be avoided by withdrawing the excess amount plus interest earned before the due date for filing your tax return.

What is the deadline for making a contribution to an IRA?
You have until April 15 to make deductible or nondeductible IRA contributions for the previous year. You must make your contribution by April 15 even if you get an extension to file your return. If you are short of cash, you may borrow to make the contribution without jeopardizing the deduction. If an IRA deduction entitles you to a refund, you can file your return early, claim the IRA deduction, and if you receive the refund in time, apply it towards an IRA contribution before the due date.

What are the income limits on deducting contributions to an IRA?
Contributions to an Individual Retirement Account (IRA) may be fully deductible, partially deductible or non-deductible on your income tax return, depending on your income level, age, and participation in an employer retirement plan. For 2008, if your adjusted gross income (AGI) is more than $159,000 ($101,000 for singles) and you are an active participant in an employer’s pension plan, you cannot take an IRA tax deduction. If your AGI is between $159,000 and $169,000 ($101,000 and $116,000 for singles), and you are an active participant in an employer’s pension plan, you can take a partial deduction for your IRA contribution. If your spouse does not actively participate in an employer’s pension plan, he or she can deduct up to the maximum IRA contribution amount.

Does receiving Social Security affect my ability to make a deductible IRA contribution?
Social Security payments you receive could restrict your ability to deduct contributions to your IRA. If you are covered by a qualified pension plan where you work, Social Security benefits can affect your deductible contribution to an IRA. Deductibility of an IRA contribution depends on your adjusted gross income, which includes the taxable portion of Social Security benefits. So your Social Security can reduce the deductible portion of an IRA contribution.

What tax form do I use to report nondeductible IRA contributions?
If you have a nondeductible Individual Retirement Account (IRA), you must still report any contributions to it to the Internal Revenue Service on IRS Form 8606, Nondeductible IRAs (Contributions, Distributions, and Basis). You must also file Form 8606 if you have received IRA distributions during the tax year and you have ever made nondeductible contributions to any of your IRAs. Form 8606 must be completed and filed with the IRS even if you don’t have to file a tax return for the year in question.

What will happen if I make a nondeductible contribution to my IRA and don’t report it to the IRS?
If you make a nondeductible contribution to your IRA, you must report it by filing IRS Form 8606, Nondeductible IRAs (Contributions, Distributions, and Basis). You face a $50 penalty if you don’t file Form 8606, and failing to file could cause confusion between you and the IRS when you start withdrawing money from the retirement account in future.

Am I allowed to mix deductible and nondeductible contributions in the same IRA?
There’s no law that prevents you from mixing deductible and nondeductible contributions in a single Individual Retirement Account (IRA), but many experts advise against it. The main problem with using a single IRA for both deductible and nondeductible contributions involves taxes. When you eventually begin making withdrawals, calculating how much of each withdrawal is taxable and how much is not could be a nightmarish task.

Does it make sense to contribute to an IRA even if I can't deduct the contribution?
Even if you can't deduct your contributions to an Individual Retirement Account (IRA), opening one and funding it once a year might still make sense. The investments you make in the account still will grow tax-free until you start making withdrawals, usually after you reach age 59 1/2. However, you might be better off taking your after-tax dollars and putting them in a Roth IRA. All earnings are tax free and neither your nondeductible contributions nor any earnings on them are taxable when you withdraw them. If you'd like to invest more than the annual contribution limit for IRA accounts, you may want to consider other tax-advantaged investments, such as annuity contracts or tax-free municipal bonds.

Should I reimburse my IRA for fees deducted for annual administration?
Always reimburse your IRA for administration fees. That way, your retirement account remains intact and you maximize the tax benefits of it. If your annual fees are $25 and remain constant over 20 years, your IRA account is reduced by $500. But that is not your true cost, since it ignores both the earnings those funds could have made if left in the account and the compounding effect.

How can I put mutual funds into an Individual Retirement Account (IRA)?
Most mutual fund companies have arrangements with a bank or trust company for people who want to put their mutual fund shares into an Individual Retirement Account (IRA). The bank or trust company is considered the "custodian" of the account, and will usually charge a modest $10 or $25 fee for its services. As an alternative, you can open a brokerage account IRA and purchase mutual funds within that. The process is similar to using a broker to buy funds normally, except that a single IRA custodian fee in the range of $25 to $50 will be charged. Some mutual funds offer IRA accounts directly. Whichever method you choose, write a separate check for your contribution. You can usually then deduct the fee on your income tax return, and you’ll have that much more money growing tax-deferred inside your Individual Retirement Account.

What can I invest my IRA money in?
You may invest your Individual Retirement Account (IRA) contribution in just about anything: Mutual funds, stocks, bonds, annuities, bank savings accounts, certificates of deposit, government bonds and investment trusts. IRAs are so flexible that the list of items that you cannot invest in is much shorter. Prohibited investments include life insurance contracts, collectibles and your own home.

Are municipal bonds a good investment for my IRA?
An Individual Retirement Account (IRA) is a great place to hold many types of investments, but municipal bonds are not among them. Municipal bonds are always free of federal income taxes, and often free of state and local taxes taxes for residents of the state of issuance. Capital gains, however, are taxable. Since they don’t generate a lot of taxable income to begin with, there’s no sense putting them in a tax-deferred IRA. If you want to own municipal bonds, invest in them outside the IRA and put your taxable investments inside the account.

Are Series EE savings bonds a good investment for my Individual Retirement Account?
Investing in Series EE U.S. savings bonds makes sense for many people. However, you should not invest in EE bonds through your Individual Retirement Account (IRA). Series EE bonds are taxed by the federal government, but generally only when you redeem them several years in the future. The bonds are always exempt from state income taxes. Investments that are put into a traditional IRA automatically grow tax-deferred until withdrawal and investments put into a Roth IRA grow tax-free. For qualified educational expenses, Series EE bonds may be tax exempt.

Can I borrow from my IRA accounts?
One of the biggest disadvantages to investing in an Individual Retirement Account (IRA) rather than in a 401(k) or similar plan is that the Internal Revenue Service will not let you borrow against the built-up value of an IRA. Nor will the government let you use an IRA as collateral for a loan. IRAs cannot be borrowed against or used as collateral for a loan. Either of these is called a ’prohibited transaction.’ If you pledge all or part of your IRA as security for a loan or you borrow from your IRA, the amount pledged or borrowed is treated as a distribution that is taxable in that year. If this pledge or loan takes place before age 59 1/2, you will also owe the 10% premature distribution penalty. This may not be a disadvantage in the long run. Both IRAs and 401(k)s are primarily for retirement or meeting long-term objectives, such as education. Borrowing against a 401(k) jeopardizes its primary purpose.

What does it mean to roll over funds into an Individual Retirement Account?
When you get a lump-sum payment from a pension plan, 401(k) or other retirement plan, you will owe taxes on the money. However, you can defer those taxes if you "roll" the check into a rollover individual retirement account. Rollover accounts differ from conventional IRAs because the money invested in a rollover account comes from an existing retirement plan. By rolling the payout into the IRA, your investment can keep growing tax-free until you start making withdrawals. IRA rollovers must follow a strict set of Internal Revenue Service rules. You must deposit the check from your old pension plan into the rollover IRA within 60 days or else face some nasty tax consequences. Only pre-tax contributions are eligible to be rolled over, and the rollover account should be kept separate from any other IRA accounts you may hold. Ask a tax professional or financial planner for the details.

What are the tax benefits of a traditional IRA?
Setting up an Individual Retirement Account (IRA) to save for your golden years is beneficial for several reasons. First, for 2008, you can contribute up to $5,000 per year ($6,000 if you are age 50 or older) to an IRA and -- depending on your income and marital status -- deduct the contribution on your income tax return to lower the amount of taxes you owe. Whether the contribution you make is deductible or not, the money you invest will grow inside the account tax-deferred until you begin making withdrawals. This effectively means that you’ll have more and more money working for you, year after year. As an added bonus, you can invest the money just about any way you wish. If you wait until you are at least 59 1/2 and retired before you start pulling money out of the IRA, you get yet another tax break. Since your tax bracket will probably be much lower when you retire than it was when you were working, a smaller portion of the withdrawals you make will go to taxes. IRAs aren’t as attractive as 401(k) plans and many other retirement programs because of the per year limit. But if you don’t qualify for one of those other plans, or if you want to supplement your savings, setting up an IRA can be a great choice. For more information, you can consult IRS Publication 590, Individual Retirement Arrangements. You can download it from the IRS Web site or order by calling 1-800-TAX-FORM (829-3676).

Do I have to itemize deductions on my income tax return to take advantage of the IRA deduction?
One of the most overlooked benefits of investing in an Individual Retirement Account is that you can take a deduction for your contribution without itemizing your tax return. No complicated paperwork is involved, but you must file Forms 1040 or 1040A rather than 1040EZ.

What tax form do I use to report nondeductible IRA contributions?
If you have a nondeductible Individual Retirement Account (IRA), you must still report any contributions to it to the Internal Revenue Service on IRS Form 8606, Nondeductible IRAs (Contributions, Distributions, and Basis). You must also file Form 8606 if you have received IRA distributions during the tax year and you have ever made nondeductible contributions to any of your IRAs. Form 8606 must be completed and filed with the IRS even if you don’t have to file a tax return for the year in question.

What will happen if I make a nondeductible contribution to my IRA and don’t report it to the IRS?
If you make a nondeductible contribution to your IRA, you must report it by filing IRS Form 8606, Nondeductible IRAs (Contributions, Distributions, and Basis). You face a $50 penalty if you don’t file Form 8606, and failing to file could cause confusion between you and the IRS when you start withdrawing money from the retirement account in future.

When must I begin withdrawing money from my IRA?
Distributions from an Individual Retirement Account (IRA) are required to begin by April 1 of the year following the tax year during which you reach age 70 1/2. If you do not start receiving distributions at that time or you receive an insufficient distribution after this date, a penalty tax of 50% applies to the difference between the amount you should have received and the amount you did receive. The IRS may waive the penalty for insufficient withdrawals if they are due to reasonable error and if steps have been taken to remedy the situation. You must submit evidence to account for shortfalls in withdrawals and how you are rectifying the situation. The IRS has indicated that examples of acceptable reasons for insufficient withdrawals includes erroneous advice from the sponsoring organization or other pension advisors or that your own good faith efforts to apply the required withdrawal formula produced a miscalculation or misunderstanding of the formula.

What tax form will I receive if I receive pension plan, annuity or insurance distributions?
If you receive a distribution from a pension plan, annuity or insurance contract, the company that makes the payment will send you a Form 1099-R. This form also is sent when your receive payments from a profit-sharing plan, Individual Retirement Account (IRA), or other tax-favored retirement program.

What is meant by a premature distribution from a retirement plan?
When you withdraw money from a retirement plan earlier than the age required by the Internal Revenue Service (59 1/2), the money you receive is known as a premature distribution and is subject to a 10% penalty unless you qualify for an exception to the penalty.

Does the IRS still impose a 15% penalty on excess distributions from an IRA?
Older taxpayers who want to make relatively large withdrawals from their Individual Retirement Accounts got major tax relief when Congress suspended the 15% penalty on so-called excess withdrawals. The Tax Relief Act of 1997 later repealed it entirely.

How will taxes be calculated if I make a lump-sum withdrawal from an IRA that includes both taxable and nontaxable contributions?
If you have made both tax-deductible and nondeductible contributions to your Individual Retirement Account (IRA) and then decide to make a lump-sum withdrawal, some of the money you pull out will be taxed and the remainder will not. Here’s an example, from "The Price Waterhouse Personal Tax Adviser" (Irwin Professional Publishing, Burr Ridge, Ill.): You have had an IRA for 10 years and now you want to make a lump-sum withdrawal. For the first eight years you made tax-deductible contributions of $2,000 each year. Your total deductible contributions: $16,000. During the last two years, you also contributed $2,000 annually, but those were nondeductible contributions. Your total nondeductible contributions: $4,000. The money you invested in the IRA generated $10,000 in profit. So altogether, you have $30,000 in the account. If you make a lump-sum withdrawal, you do not owe tax on the $4,000 in nondeductible contributions you made earlier. However, you do owe tax on the $16,000 in deductible contributions made to the account, and you also owe tax on the $10,000 in profits your investments generated. So, you are taxed on $26,000 of your $30,000 withdrawal.

What is the tax treatment of an IRA at the death of its owner?
Some complicated tax issues can arise if you die while there’s still some money left in your Individual Retirement Account. If your IRA proceeds are payable to your spouse, he or she can take the proceeds outright or may roll over the IRA account, or any part of it, into his or her own IRA account. Your spouse may also delay distribution until December 31st of the year you would have turned 70 1/2. The rollover should be direct from one account to the other. If your spouse takes the proceeds outright, no 10% penalty tax will be assessed even if the spouse is under age 59 1/2, although income taxes will be due. If the spouse rolls the proceeds directly over into an IRA of his or her own, the money from the IRA account will continue to grow tax-deferred until withdrawals begin. When the spouse eventually dies too, the assets will pass to the heirs and be subject to income taxes and (depending on the size of the estate) federal estate taxes. If the beneficiary of the IRA is not the spouse, the beneficiary may not rollover the distribution to his or her own IRA and is taxed on the distribution.

Who pays the taxes due on my IRA when I die?
When you die, your beneficiaries will pay the income tax due on distributions from your Individual Retirement Account (IRA). In the event a deceased IRA owner’s account is subject to estate taxes, the beneficiary of the IRA’s assets may deduct the federal estate taxes. This can be done in a lump sum or over a period of time as funds are withdrawn up to the amount of the estate tax paid on the IRA benefits. It should be noted that the deduction is of use only if the beneficiary has sufficient deductions to itemize rather than take the standard deduction.

Can my IRA continue compounding tax-deferred after my death?
Contributing to an Individual Retirement Account (IRA) can provide you with some important tax breaks. By carefully choosing your beneficiary, you can ensure those tax breaks will keep flowing even after you die. If you do not need to substantially deplete your IRA during your retirement, you may want to keep the tax shelter intact as long as possible for your benefit and your heirs’. Your IRA does not necessarily have to terminate at your death. Your beneficiary can maintain the IRA and retain some of the benefits of tax deferral. That is, the beneficiary must make a minimum systematic withdrawal over his or her life expectancy, but the remaining funds continue to compound tax-deferred. The rules concerning IRAs are complex, and they change frequently.

How are nonqualified Roth IRA distributions taxed?
For nonqualified distributions, contributions are always considered to be withdrawn first and come out tax-free, the earnings come out next and are taxed at ordinary income rates. If the owner is under 59 1/2, there is an additional 10% penalty on the taxable withdrawal unless certain conditions are met. Qualified distributions are tax and penalty free. A qualified distribution is a distribution, from a Roth IRA that has existed at least five years, to the Roth IRA owner who is at least 59 1/2.

How can I use my Roth IRA account to transfer assets free of estate taxes?
A Roth IRA may be useful in lowering estate taxes. This is accomplished by converting a large IRA to a Roth IRA and paying the associated income tax. For example, if an IRA account worth $1 million is converted to a Roth, which requires payment of income taxes on the transfer. The tax is $400,000 if the bracket is 40%. Paying the tax lowers the gross estate by $400,000, and the estate tax by $200,000 (in 2002), assuming the payer is in the highest estate tax bracket.

What are the rules for withdrawing from an IRA?
The rules for withdrawing money from an Individual Retirement Account (IRA) are similar to those guiding withdrawals from many other retirement plans. Most IRA investors don’t start making withdrawals until they reach 59 1/2. If you withdraw money earlier, you’ll get hit with a 10 percent penalty unless you qualify for a rare exception. Withdrawals are taxed at your individual tax rate, which will probably be lower after you retire than when you are working.

How is the minimum withdrawal from my IRA calculated?
Internal Revenue Service guidelines state that minimum distributions from an IRA must be taken in regular periodic installments over a specified number of years. The timeframe for these distributions can’t exceed your own life expectancy, or the joint life expectancy of you and your spouse. The annual payments are calculated by dividing the balance of the owner’s account at the end of the prior calendar year by the life expectancy of the owner, or the joint life expectancy of the owner and his or her spouse if the resulting life expectancy is greater, as determined for that distribution year. Since calculating minimum withdrawals is a complicated task, it’s best to get the help of an accountant or other qualified expert to make them for you.

When must I begin withdrawing money from my IRA?
Distributions from an Individual Retirement Account (IRA) are required to begin by April 1 of the year following the tax year during which you reach age 70 1/2. If you do not start receiving distributions at that time or you receive an insufficient distribution after this date, a penalty tax of 50% applies to the difference between the amount you should have received and the amount you did receive. According to J.K. Lasser’s "Your Income Tax" (Macmillan General Reference), the IRS may waive the penalty for insufficient withdrawals if they are due to reasonable error and if steps have been taken to remedy the situation. You must submit evidence to account for shortfalls in withdrawals and how you are rectifying the situation. The IRS has indicated that examples of acceptable reasons for insufficient withdrawals includes erroneous advice from the sponsoring organization or other pension advisors or that your own good faith efforts to apply the required withdrawal formula produced a miscalculation or misunderstanding of the formula.

What happens if I don’t start taking money out of my retirement account at age 70 1/2?
If you don’t start taking money out of your retirement account by the time you reach age 70 1/2, you’ll be hit with some extremely serious tax penalties. The Internal Revenue Service will slap you with a 50 percent excise tax on the difference between what you withdrew (if anything) from the account and what you should have withdrawn. On top of that, you’ll owe additional excise tax for each year you fail to make the required distribution. For example, if you should have taken $9,000 from the account but didn’t take out a cent, you would owe the IRS $4,500 for that year’s requirement. If you fail to make the required distribution for the following year, assuming it’s $8,000, you will own another $4,000 for that year. And on top of all that, you’ll owe regular income taxes on each withdrawal as well!

What is meant by a premature distribution from a retirement plan?
When you withdraw money from a retirement plan earlier than the age required by the Internal Revenue Service (59 1/2), the money you receive is known as a premature distribution and is subject to a 10% penalty unless you qualify for an exception to the penalty.

How can I take distributions from my IRA penalty-free prior to my reaching the age of 59 1/2?
In recent years Congress has added new ways to pull money out of your Individual Retirement Account (IRA) before you turn 59 1/2 and avoid paying the 10% early-withdrawal penalty.
1) Beginning in 1998, you can take distributions of up to $10,000 from your traditional or Roth IRA to buy, build or rebuild a first home without having to pay the 10% additional tax on early withdrawals.
2) You can also take distributions from your traditional IRA for qualified higher education expenses without having to pay the 10% additional tax.
3) If you are disabled, you can pull as much money as you wish out of your IRA at any age and the early-withdrawal penalty will be waived.
4) You can withdraw funds to pay pay health insurance premiums for yourself and family after the loss of a job and a minimum of 12 consecutive weeks of unemployment compensation.
5) You can use the money to pay deductible medical expenses (i.e., those in excess of 7.5% of the participant’s or IRA owner’s adjusted gross income for the year).
6) Under an adjudicated domestic relations order in settlement of a divorce. 7) If you die before reaching 59 1/2, your beneficiary or estate can receive the IRA proceeds without paying the 10% penalty and will not owe income taxes until distributions begin. This exception won’t do you any good -- after all, you’ll be gone -- but it would provide a nice tax break for your heirs.
8) You can start withdrawing the money early and avoid the penalty if you make withdrawals in "substantially equal" payments at least annually, either over your life or the joint lives of you and another beneficiary. People who utilize this exception are usually in dire financial straits and must follow a complex set of rules developed by the IRS. If they don’t follow those rules to the letter, they’ll be hit with a 10% penalty on all their early withdrawals plus accrued interest.

How will taxes be calculated if I make a lump-sum withdrawal from an IRA that includes both taxable and nontaxable contributions?
If you have made both tax-deductible and nondeductible contributions to your Individual Retirement Account (IRA) and then decide to make a lump-sum withdrawal, some of the money you pull out will be taxed and the remainder will not. Here’s an example, from "The Price Waterhouse Personal Tax Adviser" (Irwin Professional Publishing, Burr Ridge, Ill.): You have had an IRA for 10 years and now you want to make a lump-sum withdrawal. For the first eight years you made tax-deductible contributions of $2,000 each year. Your total deductible contributions: $16,000. During the last two years, you also contributed $2,000 annually, but those were nondeductible contributions. Your total nondeductible contributions: $4,000. The money you invested in the IRA generated $10,000 in profit. So altogether, you have $30,000 in the account. If you make a lump-sum withdrawal, you do not owe tax on the $4,000 in nondeductible contributions you made earlier. However, you do owe tax on the $16,000 in deductible contributions made to the account, and you also owe tax on the $10,000 in profits your investments generated. So, you are taxed on $26,000 of your $30,000 withdrawal.

Can I make penalty-free withdrawals from an IRA to buy medical insurance?

Losing your job is bad enough, but those problems can be compounded if your medical insurance disappears along with your paycheck. Since 1997, some workers who lose their jobs have been able to make penalty-free withdrawals from their Individual Retirement Account (IRA) to defray the cost of buying medical coverage. According to J.K. Lasser’s "Your Income Tax" (Macmillan General Reference), "After 1996, unemployed individuals who have received unemployment benefits under federal or state law for at least 12 weeks may make penalty-free IRA withdrawals to the extent of medical insurance premiums paid during the year. The withdrawals may be made in the year the 12-week unemployment test is met, or in the following year. However, the penalty exception does not apply to distributions made more than 60 days after the individual returns to the work force." Self-employed persons -- who are ineligible for unemployment benefits -- now can also make penalty-free withdrawals from an IRA to pay their insurance premiums.