Individual Retirement Arrangements (iras)

By Author: Jeff Parrack
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Known as IRAs, Individual Retirement Arrangements (or Accounts) are essentially retirement savings accounts that are well defined and controlled by federal legislation, which created them in the first place. They are appealing as investment vehicles for retirement because earnings are not taxed until money is withdrawn, allowing the accounts to grow and compound interest. For people who cannot manage their finances and are liable to dip into the money, IRAs are not a good idea, as there are penalties for early withdrawal (prior to age 59-1/2). Of the various kinds of IRAs now on the books, each has its own special eligibility rules, contribution guidelines and, most importantly perhaps, tax benefits.

When contributing to a "Traditional IRA," the amounts are tax-deductible. This means your taxable income is decreased and you are simply not paying taxes on that portion of your income. Because the accounts grow while taxes are deferred until withdrawal, any growth in your IRA account -- dividends, capital gains, interest -- is also absent from your tax return. You will declare these funds, and have them taxed as regular ...
... income, as you withdraw them later. You are allowed to start withdrawals, as previously mentioned, six months ahead of your 60th birthday, but in any case you must take the distributions when you hit 70-1/2 years of age.

Roth IRAs
Named for the late Senator from Deleware, William Roth, a "Roth IRA" differs from the Traditional IRA in a number of important ways. You do not get a deduction for your contributions, but your account grows without your having to pay taxes on the growth. Then, when you take the distributions from a Roth IRA, they are entirely tax-free, assuming you have met all the requirements and followed the various rules. Again, as opposed to the Traditional IRA, you can make contributions to your own Roth IRA even when covered by an employer retirement plan. If you are considering a Roth IRA, make sure to learn about the other limitations and requirements, as there are a number of things to consider.

SIMPLE IRAs
"Savings Incentive Match Plans for Employees (SIMPLE) IRAs," another group retirement arrangement, are easier to establish and maintain than either 401(k) plans or pensions, but have reduced contribution limits compared to other plans. With a SIMPLE IRA you deposit your pre-tax income, with a matching sum contributed by your employer. When you start taking your funds, they will be considered ordinary income for tax purposes. As usual, there are penalties for early withdrawals.

Nondeductible Traditional IRAs
A "Nondeductible IRA" is similar to the Traditional IRA, in that they are both tax-deferred savings plans, but differs in terms of the contributions not being deductible. Once deposited, your funds will grow as tax-deferred savings, but when you take your distributions, a portion is considered a tax-free rebate of sorts (of the original contribution) with the rest subject to ordinary income tax. Nondeductible IRAs are a popular choice for those who have a workplace retirement plan but also want to save additional funds toward retirement. The essential difference between Nondeductible and traditional IRAs is how the original contribution is treated by the tax code.

Simplified Employee Pension IRAs
A "Simplified Employee Pension (SEP) IRA" is yet another kind of group retirement setup. Employers establish the SEP IRAs, which enables them to deposit funds into Traditional IRAs that are established "inside" the SEP IRA plan. As they have higher contribution limits than Traditional IRAs, SEP IRAs are a common choice for the self-employed. In most other ways, SEP IRAs are similar to Traditional IRAs, with contributions coming from pre-tax dollars, later distributions being taxed as regular income and penalties being assessed for early distributions.

IRA contribution limits and deadlines
The highest amount you can contribute in a year to Traditional, Nondeductible and Roth IRAs is $5,000 until you reach age 50, when you can put $6,000 in each year. There is what is called a "single dollar limit" for combining any of these three IRAs, meaning you can fund both a Traditional and a Roth IRA, but your total deposits to both is still controlled by the appropriate annual limit of $5,000 or $6,000.

Your qualifying income will also affect your contributions. For IRA purposes (and IRA purposes alone, not taxes), qualifying income means wages, alimony, non-taxable combat pay and self-employment income. If you happen to have $3,500 in wages, with no income besides that, you can put $3,500 into any combination of Traditional, Nondeductible or Roth IRAs in that year. As far as deadlines and time constraints on contributions, you can put funds in an IRA any time during the year and all the way up to the April 15th filing deadline for that year's tax return.
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