Individual Retirement Account

Introduction to Individual Retirement Accounts

An IRA (Individual Retirement Account) is one of the best ways for individuals and married couples to save for retirement.  IRA’s offer numerous tax advantages, along with the opportunity to build a substantial nest egg for retirement. This article is written to provide you with IRA Information to help you make informed decisions about your individual retirement account.

For the 2009 tax year, most people are allowed to contribute up to $5,000 per year to an Individual Retirement Account, but if you are age 50 or older at the end of the year, you can contribute up to $6,000 per year to your IRA.  You are not allowed to withdraw money from your IRA until the year you reach age 59½.  If you make withdrawals from your IRA prior to reaching age 59½, your withdrawals are subject to an additional 10% tax penalty.

There are two main types of Individual Retirement Accounts: the Traditional IRA and the Roth IRA.  There are similarities between the two types of IRA’s, but there are also striking differences in terms of the tax advantages of each.

Traditional IRA’s

With traditional IRA’s, your initial contribution is tax-deductible in the year you make the contribution.  Furthermore, the earnings that accumulate in your Individual Retirement Account are tax-deferred, meaning you don’t pay income taxes on the earnings until you withdraw the funds from your account.  Your withdrawals cannot begin before the year your turn 59½, and they must begin by the year you turn 70½.  You will not pay income taxes on any of your IRA contributions or earnings until you withdraw the funds from the account.  But once you begin making withdrawals, 100% of the amount of each withdrawal is subject to income tax at the rate in effect at the time of the withdrawal.

There are restrictions on who can take a deduction for Traditional IRA contributions.  Essentially, if you or your spouse are covered by a retirement plan at work, there may be limits on the amount of your deduction, or you may not be able to take a deduction at all.

Roth IRA’s

A Roth IRA is very different from a Traditional IRA.  First of all, your initial contribution is not tax deductible, which may seem like a disadvantage compared to the Traditional IRA.  But the Roth IRA more than compensates for this, because with the Roth IRA, all of your earnings in the account are tax-free.  That means when you begin making withdrawals after age 59½, the entire amount of your withdrawal is tax-free.  This is a tremendous advantage compared to the Traditional IRA.  Also, unlike Traditional IRA’s, there is no age at which you must begin to withdraw money from your Roth IRA. As a result, Roth IRAs are an excellent tool to pass along wealth to your children or grandchildren.

You can contribute to a Roth IRA even if you are covered by a retirement plan at work.  But Roth IRA’s do have income limitations in determining who is eligible to contribute.  If your income is above certain levels, your Roth IRA contribution may be limited, or it may be phased out altogether.

Opening an Individual Retirement Account and Making Contributions

Contributions to a Traditional IRA or a Roth IRA can be made anytime during the tax year.  They can even be made after year-end, as long as they are made before the April 15 filing deadline.  Opening an Individual Retirement Account is a simple process.  Virtually any bank or brokerage firm will open an IRA account for you, and they will help you with the necessary paperwork, and answer any questions you may have.

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