Individual Retirement Accounts (IRAs) are accounts that receive preferential tax treatment when used to save for an indivual's retirement. Four types of IRAs exist: Traditional IRAs, Roth IRAs, SEP IRAs, and SIMPLE IRAs.
Some sources refer to Education IRAs, which are used to save for a child's education expenses rather than retirement. The Education IRA term is out-dated; these accounts are now referred to as Coverdell Education Savings Accounts, or ESAs. ESA information can be found in IRS Publication 970.
The acronym for SEP is Simplified Employee Pension, and for SIMPLE is Savings Incentive Match Plan for Employees of Small Employers. These types of IRAs are established by employers for their employees, and SEP IRAs can also be established by self-employed individuals. Information on these accounts can be found in IRA Publication 560.
The other two, Traditional IRAs and Roth IRAs, are established by individuals. Most all working individuals are eligible to open an IRA. The basics of these two accounts follow below.
Traditional IRAs
Must have taxable compensation during the year
Must be under age 70 & ½
May contribute any time of the year
Contributions are before-tax (tax-deductible)
Deductibility of contributions may be limited if covered by an employer retirement plan
Annual contribution limit is $5000, or $6000 if age 50 or older
Excess contributions receive 6% penalty tax
Earnings and interest grow tax-deferred (not taxed until distributed)
Distributions are taxed at ordinary income tax rate
Early distributions (before age 59 & ½) taxed at ordinary rate plus 10% penalty
Required minimum distributions must begin by age 70 & ½
Insufficient distributions receive 50% excise tax on amounts not distributed as required
Must have less than $100,000 adjusted gross income to convert account to a Roth IRA
Roth IRAs
Must have taxable compensation during the year
May contribute any time of the year
Contributions are after-tax (not deductible)
Annual contribution limit is $5000, or $6000 if age 50 or older
Contribution limits are less when income is over $101,000 if single or $159,000 if married
Excess contributions receive 6% penalty tax
Earnings and interest grow tax-exempt (not taxable if distributed after age 59 & ½)
Must hold account open for a minimum 5 years before first distribution of earnings
Distributions of contributions are never taxable
Distributions of earnings and interest are tax-exempt (if after age 59 & ½)
Early distributions of earnings taxed at 10% penalty
Required minimum distributions do not begin at any age
Current year contributions may be recharacterized as contributions to a Traditional IRA
The annual contribution limit for both the Traditional and Roth is $5,000. If you have both accounts, the $5,000 limit applies cumulatively. For example, if you contributed $2,000 to a Traditional IRA, the maximum you could contribute to a Roth IRA would be $3,000. The contribution limit will increase in $500 increments when adjusted for inflation.
The information above is based on IRS rules for year 2008. You can find current IRA details in IRS Publication 590.
