The U.S. Congress wants you to save for your own retirement. That's why it authorized tax-advantaged individual retirement accounts. And it's serious about you leaving your money in your retirement account until you're actually old enough to retire. If you move money from your IRA into a non-qualified money market account before those funds becomes qualified, the Internal Revenue Service will be waiting with its hand out.
You typically get to take a tax deduction equal to the amount of your contribution -- up to a specified annual limit -- to your traditional IRA. All of the investments in your traditional IRA grow tax-deferred as long as they remain inside the account. Once you turn 59 1/2 years old, you can start taking qualified distributions from your traditional IRA. Those distributions are treated as ordinary income by the IRS and are taxed at your tax rate as of the time of the withdrawals. If you move money from your traditional IRA to a money market account outside of your IRA before you reach age 59 1/2, you'll owe ordinary income taxes on that amount, plus an additional 10 percent tax penalty.
Traditional IRA Exceptions
You'll always owe ordinary income taxes on any money you withdraw from your traditional IRA, regardless of your age or circumstances. But under certain circumstances you might be able to avoid the additional 10 percent tax penalty. For example, you can avoid the tax penalty if you become disabled, or if you're using the money to pay for a first home. You can also move money from your current traditional IRA to a money market account held by the same or another traditional IRA trustee, either through a rollover or trustee-to-trustee transfer, without creating a taxable event.
Roth IRAs provide the same tax-deferral for investment income, but they come with a completely different set of rules for how distributions are taxed. You don't get to take a tax deduction for contributions to your Roth IRA, so any money you contribute is available for you to withdraw at any time, for any reason, without any tax consequences. You can take your contributions out of your Roth IRA and use them to open a money market account without paying income taxes or any tax penalty.
Roth IRA Earnings
The earnings portion of your Roth IRA must remain in the account for at least five years, and you must meet one additional requirement, such as being 59 1/2 years old or being disabled, before those funds become qualified. Once the earnings are qualified you can withdraw them tax-free. If you wish to move your qualified earnings to a money market account, you can do so without paying either income taxes or a tax penalty on those funds. If you withdraw your earnings before they become qualified, you'll owe ordinary income taxes on that amount, and you might be subject to the additional 10 percent tax penalty.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.