"Retard" literally means "slow." "To retard" means to slow down. "Tardy" means late (presumably because you're too slow). In music, "ritardo" means to slow your pace.
Typically, when you suggest that something or someone is "retarded," you're not actually suggesting that he or she has a true mental defect. You're using figurative language to suggest that someone's thinking process isn't up to speed.
Is it an insult? Yes, it is. Is it an awful thing to say in all circumstances? No. I mean, I wouldn't say it to someone who really is slow, but I might use it in another context, especially amongst friends or about enemies. It's full meaning depends upon how and when it's used. By itself, it is not an awful word.
Sarah Palin urges Obama to fire his chief of staff because he used the word "retarded."
Way to go, Sarah. Your little protest has only deepened the meaning of the offensive word.
On the other hand, you do have to wonder what kind of public figure decides to drop the "retarded" bomb. I'm not so much amazed by his insensitivity as I am to his utter foolishness. In a way, he also deepened the meaning of the offensive word.