Function

• In an IRA account, the earnings, such as interest, capital gains and dividends, grow on a tax-deferred basis. Unlike a taxable investment account, you do not have to report and pay taxes on these earnings annually. Theoretically, the longer you let tax-deferred growth work for you, the more your account will grow. To this end, Congress intends IRAs to serve investors primarily as retirement savings vehicles. To encourage you to keep IRA money invested into retirement, the IRS levies a 10 percent tax penalty on most IRA distributions taken prior to retirement.
  
  

Time Frame

• The IRS uses 59 1/2 years of age as its retirement age. Generally, when you take an IRA distribution at this age, you do not pay the 10 percent tax penalty. As IRS Publication 590 notes, however, you must have also held your Roth IRA account for a minimum of five tax years to escape the penalty. You'll still pay applicable regular federal income tax on withdrawals. In most cases, the IRS taxes the entire amount of your traditional IRA withdrawals but does not tax Roth distributions, including earnings, as long as you satisfy both the 59 1/2 years of age rule and the five-year rule.
  
  

Exceptions

• There are exceptions to the above-mentioned rules. Publication 590 details them all, including the least common. Two of the most common exemptions to both the 59 1/2 years of age rule and the Roth five-year mandate are allowed when using IRA money to fund higher education expenses or first-time home buyer expenses. The IRS also exempts you from the penalty if you take IRA withdrawals because you have become disabled or are using the money to satisfy an IRS lien.
  
  

Considerations

• You can use the higher education and first-time home buyer exemptions for yourself, your spouse, your children or your grandchildren. The IRS does not limit the amount of IRA money you can withdraw to cover higher education expenses, as long as the amount is not greater than the expenses paid. Qualified expenses include tuition, mandatory fees, room and board and supplies for students enrolled at least half-time at institutions authorized to participate in federal financial aid programs. Additionally, as Publication 590 points out, the IRS caps the first-time home buyer benefit at $10,000 over your lifetime.
  
  

Warning

• The IRS uses another penalty against traditional IRA owners only. In the year after you turn 70 1/2 years of age, the IRS expects you to start taking a required minimum distribution annually. If you don't, the IRS levies a 50 percent excise tax on the amount of money you should have taken, which is based on your age, account value and life expectancy.