We Know: All About IRAs

What is an IRA?

The Individual Retirement Arrangement is commonly known as an Individual Retirement Account, or IRA for short. An IRA is a personal retirement savings plan available to individuals who have earned taxable income during the year. The amount you contribute depends on the Adjusted Gross Income (AGI). Couples can contribute up to $4000 per year ($2000 for the spouse and $2000 for yourself). The tax-deductibility of contributions decreases as you reach an upper income limit. Additional contributions known as "catch-up" contributions can be made if your are over age 50. The earnings remain tax-deferred until the money is withdrawn, usually at or after the age of 59 1/2. Any withdrawals taken prior to the legal retirement age is subject to penalties.

How many different types of IRAs are there?

There are 11 different types of IRAs. They are:

  1. Individual Retirement Account
    • Traditional IRA or Roth IRA
    • Set up in a financial institution
    • Can be in the form of certificate of deposits (CDs) or securities (stocks and bonds).
    • You pay taxes on the profit and savings
  2. Individual Retirement Annuity
    • Set up through a life insurance company
    • Requires a special annuity contract
  3. Employer and Employee Association Trust Account - Group IRA
    • Can be opened by employers or employee associations for employees
  4. Simplified Employee Pension - SEP IRA
    • An IRA that is created by an employer for him/herself and his/her employees
  5. Savings Incentive Match Plan for Employees - SIMPLE-IRA
    • Plan created by small businesses who make matching contributions based on a percentage of the employee's pay
  6. Spousal IRA
    • For spouses with less than $2000 of taxable income
    • Working spouses can contribute up to $2000 for the nonworking spouse
  7. Rollover IRA
    • An IRA created from an existing retirement account at a place of employment
    • Usually allows rollover of funds from a 401(k) without penalties
  8. Inherited IRA
    • For non-spousal beneficiaries of the IRA owner
    • Not tax deductible
  9. Education IRA
    • College-savings account for dependents
    • Contributions are not tax deductible, but earnings are tax-deferred and tax-exempt if used for qualified educational costs
  10. Traditional IRA
    • Commonly known as "the IRA"
    • Can be created for individuals under the age of 70 1/2 with taxable income
    • Earnings are tax-deferred until withdrawn
    • Regular withdrawals must be made by age 70 1/2 or a 50% excise tax is imposed
  11. Roth IRA
    • Contributions made are not tax-deductible
    • Earnings are not tax-deferred but distributions are tax-exempt
    • Contributions are phased out above a limit of $150,000 for joint filers

Which individual retirement account should I choose: Roth or Traditional IRA?

The difference between the Traditional IRA and the Roth IRA is the point at which you'll pay the tax on your earnings. With the traditional IRA,you can make tax-deductible contributions to an account without paying for taxes until you withdraw the money. With the Roth IRA, your contributions are taxed up front, but any withdrawals made at or after the retirement age are not subject to taxes if you've maintained the account for at least five years. Roth IRAs are good for those who can't otherwise make tax-deductible contributions to a Traditional IRA. You can convert a Traditional IRA to a Roth IRA, but you'll have to pay taxes on the "withdrawn" amount from the old IRA.

How does a SEP IRA work?

SEP IRAs can only be established by the self-employed for themselves and their employees. Sole proprietors, business owners, or business partners in a business can put aside up to 25% of their self-employment income towards an IRA. The business must have made a profit for the SEP IRA to apply.

With the SEP IRA, you create IRAs for yourself and your employees and make contributions on behalf of your employees to each separate SEP IRA. Contributions must be made by April 15th in order to qualify for tax-deductible status. SEP IRAs do not require yearly contributions, and must be funded through a trust or custodial account. The earnings are tax-deferred until withdrawn at retirement.

Can I take money out of my IRA if I need it before I reach retirement?

Since the intention of an IRA is to provide individuals with savings for retirement, you are strongly discouraged from taking any withdrawals. If you need to make a withdrawal before you reach retirement, you'll be assessed a 10% excise tax plus the income tax for the amount disbursed, except if your withdrawal is for one of the following reasons:

  • Withdrawal is made in the event of your disability
  • Withdrawal is made as a result of your death
  • Payments are "substantially equal periodic payments" made over your life expectancy
  • The disbursal is used for unreimbursed medical expenses over the 7.5% of your AGI
  • The disbursal is going towards the purchase of a first home
  • Payment for higher education expenses incurred by dependents
  • When the IRS places a lien against your IRA for back taxes owed

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