Individual Retirement Accounts

Frequently Asked Questions

Q: What is an IRA?

A: An IRA is an Indvidual Retirement Account. It's purpose is to allow the individual a savings plan that provides income tax advantages specficially to those saving money for retirement purposes.

Q: How does an IRA work?

A: You invest money in an IRA, up to the amounts allowable under the tax law (see Tax Law sections for more details). These investments are called "contributions." In many situations an income tax deduction is avaialable for the tax year during which these funds are contributed. These contributions, as well as any earnings or gains from said contributions, accumulate tax-free until you withdraw money from your account. Simply, you enjoy the ability to generate additional earnings, unreduced by taxes on these earnings, each year the funds remain in the IRA.

If you withdraw from an IRA, it is termed a distribution. Distributions are  subject to income taxation, generally in the year in which you receive them. Many laws are in place that keep you from withdrawing a too young of an age, as well as withdrawing it too soon.

Q: What are the different types of IRA's?

A: There are five different types of IRA's:

1. Traditional IRA
You can contributed up to $2,000 per year into an IRA. The amount of this contribution that is deductible on your income tax return depends on your AGI, or Adjusted Gross Income, and whether or not you are covered under an employer sponsored qualified retirement plan. Thus, depending on your filing status (Single, Joint, etc), and your AGI, your contributions may range from fullly deductible to totally non-deductible. So even though you are eligible to contribute to your IRA, you may be in a position where none of these contributions are, in fact, deductible.

2. Education IRA
You can put away up to %500 per year into an education IRA< the money grows tax-free and has preferential tax treatment upon distrbution to the beneficiary who uses it for authorized education expenses. These plans are not very common in that they are very restrictive on who can make contributions to them, the amount of total contributions allowable each year, and the limitations on what exact education expenses qualify. Your financial planner should be able to assist you in evaluating what savings plan you should undertake to prepare for higher education costs, as well as in reviewing many of the tax-sheltered savings plans now sponsored by the various states, even for benefits of non-state residents.

3. Simplified Employee Pension (SEP) IRA
This is an employer established and funded IRA, where the employer can put up to 15% of your compensation into a special IRA account. Sole proprietors may establish these plans for their own benefit. They are sometimes used instead of Keogh retirement plans because they have fewer administrative and tax filing requirements.

4. Simple IRA
A fairly new IRA, but it is enjoying rapid popularity gain. It's another employee sponsored and administered retirement plan. The attractive features of this plan includes not only the ability for the employer to establish and fund a retirement plan, but it also permits employees to contribute up to 100%, but no more than $6,500 per year, into an IRA. Seperate rules relative to required employee contributions and premature distrbutions apply.

5. ROTH IRA
Contributions are not deductible when the funds are contributed, but the Roth IRA earnings accumulate tax-free and remain tax-free upon distribution. To be eligible to contribute, your Adjusted Gross Income must be under $95,000 for singles and $150,000 for married couples, as of December 2000. You cannot withdraw your funds within the first five years after establishment of the Roth without a penalty. Given that this 5-year testing period can successfully be addressed by proper tax planning, the establishment and at least partial funding of a Roth IRA account should be on the discussion list of the financial advisor of every taxpayer who qualifies to open such a plan.

Q: Who is eligible to open an IRA?

A: 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 compensation during the year and you were not 70 and a half years old by the end of the year.

Q: How do I open/sign-up for an IRA?

A: Only certain organizations can open an Individual Retirement Account for you. They are called trustess or custodians.The IRS may approve certain financial institutions, mutual funds, stock brokerage firms, or insurance companies to act as a trustee or custodian for IRAs. You may also choose to open your IRA through a bank, a savings and loan association, or a federally insurced credit union. It takes a written document to open your IRA and it must be done in the United States.

Q: How do I decide which IRA is right for me?

A: It depends on your taxable income, and your age and family status. The best way is to meet with a financial advisor, to help you determine which type of strategy will work best for you.

For more information, please visit The Internet Retirment Alliance for long term financial planning and IRA information.