Q. IRAs are apparently a key part of retirement planning. What exactly is an
IRA, and what are the benefits of having one? Where do I go to get started?
A. IRA stands for Individual Retirement Account. An IRA is a personal
savings plan that allows you, or sometimes your employer, to save and invest
money that will be used during your retirement. In most cases, an IRA
provides tax advantages unavailable through a traditional savings account or
other investment vehicle. In general, you can contribute up to $2,000 per
year into your IRA and often deduct a portion of your contribution from your
taxable income. You then direct those funds into a number of investment
vehicles, usually after consulting with a financial planner. The money you
contribute, as well as the earnings and gains from these contributions,
accumulates tax-free until you withdraw the money from the account. You
therefore enjoy the ability to generate additional earnings, unreduced by
taxes, each year the funds remain in the IRA.
There are four kinds of IRAs that can be established for retirement purposes
(there is also one that assists with savings for higher education, for which
the term “IRA” is a bit of a misnomer). They include the traditional IRA,
the Roth IRA, the Simplified Employee Pension (SEP) IRA, and the Simple IRA
(SIMPLE). The traditional IRA and the Roth IRA are those opened directly by
individuals. The SEP IRA and SIMPLE are employer-sponsored accounts, but may
be of interest if you are self-employed. You can also hold multiple IRAs
through different organizations. Here we will introduce the traditional IRA
and the Roth IRA, but be sure to work with your financial planner in
choosing the IRA that is right for you.
The traditional IRA: Any individual can open and make contributions to a
traditional IRA, as long as you or your spouse (if you file a joint return),
received taxable earned income during the year and were not 70 ˝ years old
by the year’s end. You can contribute up to $2,000 per year. The amount of
your contribution that is tax deductible depends on your filing status
(Single, Joint, etc.) and your Adjusted Gross Income (AGI). Your
contributions may range from fully deductible to totally non-deductible.
The government expects you to begin withdrawing funds from the traditional
IRA between age 59˝ and 70˝. The withdrawals, or “distributions,” will be
taxed, generally for the year in which you receive them. You may withdraw
funds before age 59˝, but they will be subject to taxation and a 10 %
penalty, unless certain exceptions apply. In many cases, the penalty can be
avoided with proper planning, but professional advice is essential. A stiff
penalty also applies if you fail to make minimum withdrawals after age 70˝.
Government rules regarding these minimum distributions are among the most
complex of the Internal Revenue Code. The penalty is 50% of the shortfall
between what you should have withdrawn and the amounts you actually withdrew
by the proper date.
The Roth IRA: Contributions to Roth IRAs are subject to income limitations.
As of December 2000, the maximum yearly contribution that can be made to a
Roth IRA is phased out for a single taxpayer with an AGI between $95,000 and
$110,000, for joint filers with an AGI between $150,000 and $160,000, and
for people who are married, filing separately with an AGI between $0 and
$10,000. Contributions are not tax deductible when the funds are
contributed, but the Roth IRA earnings accumulate tax-free and remain
tax-free upon distribution. There are also no minimum distribution
requirements for the Roth IRA, which means you can leave funds in your
account for as long as you live. You also can contribute to your Roth IRA
after age 70 ˝, which you cannot do with a traditional IRA. You cannot
withdraw your funds during the first five years of your account without a
penalty, but this five-year period may be addressed by proper tax planning.
Every qualified taxpayer should discuss the establishment of a Roth IRA with
his or her financial planner.
You can open an IRA at any organization approved by the IRS. This includes
many financial institutions such as mutual fund or stock brokerage firms,
insurance companies, banks, savings and loan associations, and federally
insured credit unions. The specific investment vehicles available for your
IRA funds depend on the organization you choose. It takes a written document
to open your IRA, and it must be done in the United States. There may or may
not be a fee. Some plans charge nothing, while others charge $10 per fund or
$35-60 per account, or more. Each has different services and benefits; find
out specifically what they offer and then determine which plan is best for