What You Need to Know to Understand IRAs

Helping Your Retirement Planning

by Benjamin Roussey

You cannot stay young forever, so it is better that you plan early for your retirement years.  It doesn’t matter if you have just started in your career, be it a job in a company or self-employment, an individual retirement account should be given a serious thought.

What Is an IRA?

An Individual Retirement Account (IRA) is a personal savings retirement plan which offers specific tax benefits for retirement savings. The amount invested in these accounts (subject to certain limitations) saves the amount you contribute in it from being taxed. An IRA provides financial security for those looking at retirement.

Sure there are 401(k) accounts, but they are limited to the fact that they can only be accessed by those who are employed and work for a company. People who are self-employed cannot benefit from it. So an IRA is the only possible alternative.

How Does an IRA Function?

The investments you make into an IRA are termed as contributions, and the withdrawal of funds is termed distributions. The contributions and any subsequent gains grow tax-free until you withdraw the funds. The sole purpose of an IRA is to help you plan for your retirement, so if you withdraw funds prior to the age of 59 ½, you are subject to a tax penalty of 10 percent on the amount, known as premature distribution. This penalty is raised once you reach an age of 59 and six months.

Different Types of IRAs

The different types of IRAs you can open are:

• Traditional IRA: Allows you to contribute no more than $5,000 per annum. This type of IRA is further classified as Deductible IRA and Non-deductible IRA. How this is decided depends on the nature of your contributions, filing status (joint, single), employment status and your Adjusted Gross Income (AGI). Therefore, even if you are eligible for an account of this sort, it might not benefit you. It would be better to consult a financial consultant to understand your status. The investor should be below the age of 70 years and six months to contribute to these. The contributions are tax deductible.
• Roth IRA: Almost the same as Traditional IRA in terms of annual contribution ($5,000 per year) and age requirements, it does have some differences. Unlike a traditional account, which only requires you to have a taxable income in order to contribute, your AGI for a Roth IRA must be less than $110,000 if you are single or $160,000 if you are married. Another difference lies in the fact that for the initial five years of contribution, if you withdraw funds, you will be subject to penalties. The money which is contributed into Roth IRAs is already taxed, so when you retire and withdraw them no additional tax is imposed.
• SEP IRA: Offers provisions for an employer (self-employed individual or small business owners) to make contributions to a Traditional IRA. Instead of being established in the company’s name, the IRA is established in the individual’s name. These have less tax filing as well as administrative requirements.
• Simple IRA: A relatively newer offering which has gained popularity and momentum owing to several advantages it offers. The most attractive feature lies in the fact that you can contribute up to 100 percent of your income into an IRA, but not more than $6,500 per year.
• Educational IRA: Allows the person to contribute $500 annually into the retirement account. It is now known as a Coverdell Education Savings Account.

When you sit down to plan for your retirement, make sure to go through the advantages and disadvantages offered by the different types of IRA and decide what you expect your future needs will be. Hire a financial consultant to help you decide. An IRA could be the wisest move you make in ensuring a happy life ahead for you and your family.