An Individual Retirement Account is a personal savings plan that serves as an investment vehicle geared toward retirement savings. There are several types of IRAs, including Traditional, Roth, SIMPLE and SEP.
Traditional and Roth IRAS are established by individual taxpayers, who are allowed to contribute 100 percent of compensation up to a set maximum dollar amount. Contributions to Traditional IRAs may be tax deductible depending on an individual’s income, tax filing status and coverage by an employer-sponsored retirement plan. Contributions to a Roth IRA are not tax-deductible. SIMPLE and SEP IRAs are established by employers and individual contributions can be made to these accounts.
IRA contributions, as well as the earnings and gains from these contributions, accumulate tax-free until you withdraw the money from the account. With the exception of Roth IRAs, withdrawals, also referred to as distributions, are taxed as income. Because income may be lower once you reach retirement, tax rates may be lower at that time. IRAs can prove to be very valuable tax-management tools when combined with potential tax savings at the time of contribution. Also, depending on income, making tax-deductible contributions during working years may allow an individual to stay within a lower tax bracket until reaching retirement.
Since the original purpose of the IRA is to assist individuals in providing for retirement, a 10 percent tax “penalty” may apply as a deterrent to withdrawing IRA funds prior to an assumed retirement age of 59 1/2. Individuals usually need to begin taking distributions from their IRA no later than April 1 of the calendar year following the date that the individual has reached age 70 1/2.
To find out more on IRAs, visit the IRS’s IRA Online Resource Guide at http://www.irs.gov/retirement/article/0,,id=137320,00.html.