Individual Retirement Accounts (IRA)

An IRA is an investing tool used by individuals to earn and select funds for retirement savings. There are different types of IRAs.

 

Traditional and Roth IRAs

Traditional and Roth IRAs are established by individual taxpayers. They are allowed to contribute 100% of compensation (self-employment income for sole proprietors and partners) up to a set maximum dollar amount.

Tax deduction

Contributions to the Traditional IRA may be tax deductible depending on the taxpayer’s income, tax filing status and coverage by an employer-sponsored retirement plan.

Roth IRA contributions are not tax-deductible.

 

SEPs and SIMPLEs

A SEP IRA is a provision that allows an employer (typically a small business or self-employed individual) to make retirement plan contributions into a Traditional IRA established in the employee’s name, instead of to a pension fund in the company’s name.

A SIMPLE IRA is a Savings Incentive Match Plan for Employees that requires employer matching contributions to the plan whenever an employee makes a contribution. The plan is similar to a 401(k) plan, but with lower contribution limits and simpler (and thus less costly) administration. Although it is termed an IRA, it is treated separately.

 

Self-Directed IRA

A Self-Directed IRA is an IRA that permits the account holder to make investments on behalf of the retirement plan.

 

Rollover IRA and Conduit IRA

There are two other subtypes of IRA, named Rollover IRA and Conduit IRA, that are viewed by some as obsolete under current tax law (their functions have been subsumed by the Traditional IRA); but this tax law is set to expire unless extended. However, some individuals still maintain these arrangements in order to keep track of the source of these assets. One key reason is that some qualified plans will accept rollovers from IRAs only if they are conduit/rollover IRAs.

 

Educational IRA (Coverdell Education Savings Account)

What was formerly known as an Educational IRA is now called a Coverdell Education Savings Account.

 

 

 

Tax management

With the exception of Roth IRAs, where eligible distributions are tax-free, eventual withdrawal from an IRA is taxed as income; including the capital gains. Because income is likely to be lower after retirement, the tax rate may be lower. Combined with potential tax savings at the time of contribution, IRAs can prove to be very valuable tax management tools for individuals. Also, depending on income, an individual may be able to fit into a lower tax bracket with tax-deductible contributions during his or her working years while still enjoying a low tax bracket during retirement.

 

Individual retirement plan

An Individual Retirement Account is a form of “individual retirement plan”, provided by many financial institutions, that provides tax advantages for retirement savings in the United States. An individual retirement account is a type of “individual retirement arrangement” as described in IRS Publication 590, Individual Retirement Arrangements (IRAs). The term IRA, used to describe both individual retirement accounts and the broader category of individual retirement arrangements, encompasses an individual retirement account; a trust or custodial account set up for the exclusive benefit of taxpayers or their beneficiaries; and an individual retirement annuity, by which the taxpayers purchase an annuity contract or an endowment contract from a life insurance company.

 

Relaxed restrictions

Starting with the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), many of the restrictions of what type of funds could be rolled into an IRA and what type of plans IRA funds could be rolled into were significantly relaxed. Additional acts have further relaxed similar restrictions. Essentially, most retirement plans can be rolled into an IRA after meeting certain criteria, and most retirement plans can accept funds from an IRA. An example of an exception is a non-governmental 457 plan which cannot be rolled into anything but another non-governmental 457 plan.