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Individual Retirement Accounts

INDIVIDUAL RETIREMENT ACCOUNTS

An Individual Retirement Account (IRA) provides some form of tax advantage to assets held by an individual until retirement, with certain exceptions. Despite the recent trend toward the use of the 401(k) and similar plans, the IRA is still a valuable tool for retirement planning and other goals. The types of IRAs are traditional, Roth, education, SEP, and SIMPLE; all of them use one of two forms of preferential tax treatments affecting contributions and gains. Individuals, small businesses, and the self-employed can all potentially use IRAs. The Internal Revenue Service (IRS) does not dictate the type of investment held in an IRA; investors can use stocks, bonds, mutual funds, and others (Preston). The investment choice should be determined by investment horizon, risk tolerance, and possibly investment savvy (Hanna and Chen).

The traditional IRA has been available for some time. The Roth IRA was born out of the 1997 Taxpayer Relief Act and provides a different tax advantage than other types of retirement savings vehicles, which will be discussed later. The 2001 Taxpayer Relief Act (2001 TRA) brought changes to contribution limits and will be in effect beginning in 2002. These changes will be highlighted where applicable.

Traditional IRA

The traditional IRA allows an individual to place up to $2,000 per year in an account on a tax-deferred basis. This means that the contribution is not counted as taxable income the year it is contributed and will not be taxed until it is withdrawn. This also applies to any earnings on the contributions. Each member of a married couple may have his or her own IRA and may contribute as much as $2,000 per person. The 2001 TRA has provided for increases in this amount. The contribution allowed per person increases to $3,000 between 2002 and 2004, increases again to $4,000 from 2005 to 2007, and finally reaches $5,000 for 2008 and beyond. The contribution amount will be indexed for inflation after 2008 and will increase in increments of $500. A special catch-up provision is instituted for taxpayers age fifty and over. Taxpayers who are fifty or over during 2002 may make an additional $500 contribution between 2002 and 2005 and an additional $1,000 beginning in 2006.

A qualified contribution reduces the amount of income that will be used in computing the total income tax owed because the contribution is not taxable income. The investment gains and the principal will be taxed as the distributions are taken. The actual reduction in tax liability is equal to the amount of the contribution multiplied by the marginal tax rate, the tax rate on the last dollar earned. For example, if Matt can contribute $2,000 to an IRA and he is in the 28 percent marginal tax bracket, he would save about $560 (2000 × 0.28) on his tax bill by contributing to a traditional IRA.

Households can contribute some amount to a traditional IRA as long as the taxpayer will not be seventy and one-half by the end of the year and has earned income for the year. The exception to the earned income rule is a nonworking spouse, who may contribute to an IRA provided that the couple's combined income less IRA contributions is greater than $2,000. This spousal IRA allows for a contribution to be made by one spouse on behalf of the other, who has little or no monetary compensation. The amount of the allowable contribution can be reduced or phased out as the household's modified adjusted gross income (MAGI) increases. The MAGI is the adjusted gross income plus exempt qualified interest, such as interest from a municipal bond. The rules for the phaseout are determined by whether or not the individual is participating in an employer-provided retirement plan. In the case of a married couple where one spouse is covered by such a plan and the other is not, the allowable contribution is based on each spouse's own situation. Employer-provided retirement plans include 401(k), SEP, SIMPLE, tax-sheltered annuities, and defined benefit plans.

In addition to annual contributions, three types of transfers can fund traditional IRAs. The first is a transfer from one IRA provider to another. This does not involve any direct payment or distribution to the investor, and hence there are no tax implications. A transfer from a traditional IRA or defined contribution plan to another IRA, also known as a rollover, must be declared, but if it is contributed within sixty days of the distribution, the rollover is tax-free; otherwise there will be a penalty on any distribution that was not frozen during that time. Frozen assets are those that cannot be withdrawn from the financial institution because the institution is insolvent or the state where the institution is located restricts withdrawals because of insolvency. Further, if the distribution is not a direct rollover, or is paid to the owner, 20 percent must be withheld and is taxable. Only the amount in the account that could be taxed can be rolled over. Last, the amount of an IRA transferred into another IRA because of a divorce settlement is tax-free.

Distributions from the traditional IRA can begin without penalty after the account holder reaches age fifty-nine and one-half. Withdrawals prior to that age incur a 10 percent federal tax penalty unless they meet one of the criteria determined by the IRS. One is payment of medical costs. These medical expenses must not be reimbursed and must exceed 7.5 percent of adjusted gross income (AGI). Second, withdrawals are allowed before fifty-nine and one-half when funds are needed because of recent disability. A third situation that avoids the 10 percent penalty is if a person is the beneficiary of an inherited IRA. Fourth, withdrawal of a sum not in excess of qualified higher education expenses, such as tuition and books, is permitted. An additional provision allows up to $10,000 to be withdrawn and applied toward purchasing or building a first home. Distributions from an IRA must begin by April 1 in the year after the account holder reaches seventy and one-half. If the entire amount is not withdrawn, then a schedule based on the owner's life expectancy must be followed for the distributions. Under this provision, annuity payments taken prior to fifty-nine and one-half are not penalized.

IRAs can be passed to heirs (more than one) and are included in the estate of the deceased. However, only the spouse of the decedent can take over the IRA; others cannot contribute to, roll over, or roll over assets into the IRA. Inherited IRAs must be withdrawn entirely within the first five years after the owner's death or over the life expectancy of the beneficiary. If this person is not the spouse, the serial withdrawals begin after the first year following the death of the IRA owner; a spouse can wait until the time at which the deceased would have been seventy and one-half.

Roth IRA

As part of the 1997 Taxpayer Relief Act, the Roth IRA was introduced to provide taxpayers with a unique means of saving for retirement and other goals. The principal difference between the Roth and the traditional IRAs is related to the taxation of contributions and distributions. While a deduction can be taken for contributions to a traditional IRA, there is no deduction for contributions to a Roth IRA. Instead, the earnings grow tax-exempt. This means that when money is withdrawn, there will be no taxes to pay. Therefore the key difference between Roth and traditional IRAs is that with the Roth, taxes are paid on contributions but not in retirement, and the opposite is true for the traditional IRA.

The Roth IRA may be preferable to a traditional IRA. The question one must answer to determine which one is best is at what rate the individual would like to pay taxes. While this may require making some assumptions about one's income sources in retirement, and assuming that tax laws will not change, it is still a reasonable approach to deciding which choice is best. If one expects his or her tax rate to increase in retirement, then a Roth IRA is preferable. This might be the situation for many young individuals, especially those just finishing college. If one expects it to decrease in retirement, then a traditional IRA is preferable. This may be the case for one who is making this choice later in life and is more established in his or her career.

As with a traditional IRA, individuals can place $2,000 into a Roth IRA each year ($4,000 for married couples). The increases provided by the 2001 TRA discussed for the contributions to a traditional IRA are also applicable to the Roth IRA. The rules regarding spousal Roth IRAs are the same as those for the traditional spousal IRA. The phaseout for allowable contributions for a Roth IRA is the same as that for those not participating in employer-sponsored retirement plans for the traditional IRA. Contributions to a Roth IRA can be made at any age, even beyond seventy and one-half.

Generally the rollover provisions of a Roth IRA are similar to those of a traditional IRA. In order to be eligible for a traditional-to-Roth rollover, certain conditions must be met. Failure to meet these guidelines subjects the rollover to a 6 percent federal tax for excess contributions as well as the 10 percent federal tax penalty; it also is included in ordinary income, and thus is subject to income taxes. Prior to 1999 the traditional-to-Roth rollover distribution could be taken over a four-year period, but this is not the case for new or current rollovers.

Distributions from a Roth IRA will be tax-free as long as they have been held in the IRA for five years or more and are withdrawn for appropriate reasons (the same as those for a traditional IRA). Otherwise, the early withdrawal penalty applies to the total amount withdrawn in that year. Unlike the traditional IRA, the rule requiring distributions to begin by age seventy and one-half does not apply to the Roth IRA. However, the rules regarding distributions after the owner's death are the same as those for the traditional IRA.

Education IRA

The education IRA, although similar to a Roth, has several important differences. Like the Roth, the education IRA does not provide a current tax deduction but does allow for tax-free growth of the investment principal, and has the same phaseout rules for allowable contributions. The purpose of the education IRA is to save for qualified higher education expenses for the named beneficiary. These expenses include tuition, fees, books, and room and board for students enrolled at least half-time, and as of 2002 will also include expenses for elementary and secondary schools. The contributions to this IRA must be made before the beneficiary reaches eighteen years of age and must be made in cash. The cash stipulation differs from other IRAs, for which the contributions can also be in the form of securities. Another important difference is that the contribution for an education IRA cannot exceed $500 per year per child. However, this limit increases to $2,000 after 2001. Excess contributions face the same rules as the Roth IRA, but if there are contributions made on the child's behalf to a qualified state tuition program, such as a Section 529 plan or prepaid tuition plan, then any amount contributed to the education IRA is considered excess. Excess contributions must be withdrawn by year-end or face a 10 percent penalty.

The distributions from an education IRA in any year cannot exceed the amount of qualified higher education expenses. Otherwise, the same rules apply for withdrawal and bequests that exist for traditional and Roth IRAs. The only exception is that the funds must be distributed by the time the beneficiary is thirty years old or, if the beneficiary dies, the assets must be distributed to that person's beneficiaries within thirty days from the time of death. If the person is a minor or does not have a will then state laws of intestacy will dictate the beneficiary.

SEP-IRA

The fourth type of IRA is a Simplified Employee Pension (SEP-IRA), which allows employers to make contributions on behalf of qualified employees. To qualify, an employee must be at least twenty-one years old, have worked three out of the five previous years for the employer, and earned at least $400 of compensation in the year contributions are made.

The contribution by the employer on behalf of an employee for the SEP-IRA is limited to the lesser of $30,000 or 15 percent of the employee's compensation, excluding the employer contribution to a tax-deferred account; a SEP-IRA cannot be a Roth IRA. Although employees can also contribute to this account, the same rules for contributions apply as in a traditional IRA. Further, the SEP-IRA is considered an employer-sponsored plan, and thus any contributions by the employee are subject to the same phaseout rules that govern the traditional IRA. Rules regarding distributions are the same as those for a traditional IRA.

SIMPLE IRA

The fifth type of IRA is the Savings Incentive Match Plan for Employees (SIMPLE). A SIMPLE plan allows an employee to allocate a portion of his or her income to an IRA as long as the employee received at least $5,000 in compensation in one of the previous two years and will receive at least $5,000 during the current year. Further, employees whose benefits are covered by a union, who are nonresident aliens, or who would not have been eligible if not for an acquisition, disposition, or similar activity do not need to be included in the SIMPLE plan.

The contribution is limited to $6,000 per year. As part of the 2001 TRA, the annual contribution increases to $7,000 in 2002, and will increase in $1,000 increments per year, up to $10,000 in 2005. After 2005, the contribution will be indexed to inflation and increase in $500 increments. Employers are required to contribute between 1 and 3 percent of the individual's compensation, but the amount can be only 1 percent for two of the five years following the election period. Rules regarding distributions are the same as those for a traditional IRA. A SIMPLE IRA cannot be a Roth IRA.

Who is using IRAs?

Results from the 1998 Survey of Consumer Finances (SCF) show that almost 49 percent of U.S. households have some type of retirement account, an increase of more than three percentage points over 1995 (Kennickell et al.). The SCF provides more specific data regarding ownership of IRAs (Kennickell). Additional statistics were computed using data from the 1998 SCF to determine the percentage of individuals between nineteen and ninety-five years of age using IRAs during 1997. Over 28 percent owned an IRA in 1997, and the average balance was $20,209. The proportion of those owning IRAs increases with age, then decreases for those approaching retirement. The amount invested also increases with age, then begins to decrease, which is consistent with the fact that when a person retires, he or she is receiving distributions.

The overall strategy when deciding on an IRA is determining the best time to pay taxes, which is when the marginal tax rate is lowest. Further information can be obtained from Publication 590 of the U.S. Department of the Treasury.

Michael Steven Gutter

See also Retirement Planning.

BIBLIOGRAPHY

Hanna, S., and Chen, P. "Subjective and Objective Risk Tolerance: Implications for Optimal Portfolios." Financial Counseling and Planning 8, no. 2 (1997): 1726.

Hoffman, W. H.; Smith, J. E.; and Willis, E., eds. Individual Income Taxes: 2001 Edition. Cincinnati: South-Western College Publishing, 2001.

Kennickell, A. B. Codebook for 1998 Survey of Consumer Finances. Washington, D.C.: Federal Reserve System, 1997.

Kennickell, A. B.; Starr-McCluer, M.; and Surette, B. "Recent Changes in U.S. Family Finances: Results from the 1998 Survey of Consumer Finances." Federal Reserve Bulletin 86, no. 1 (2000): 129.

Preston, R. "The Dos and Don'ts of IRA Investing." Journal of Accountancy 189, no. 4 (April 2000): 4553.

U.S. Department of the Treasury. "Individual Retirement Arrangements." Publication 590, 1999. http://www.irs.ustreas.gov/

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Gutter, Michael Steven. "Individual Retirement Accounts." Encyclopedia of Aging. 2002. Encyclopedia.com. 25 Sep. 2016 <http://www.encyclopedia.com>.

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Individual Retirement Accounts (IRAs)

Individual Retirement Accounts (IRAs)

An individual retirement account (IRA) is a tax-deferred retirement program in which any employed person can participate, including self-employed persons and small business owners. In most cases, the money placed in an IRA is deducted from the worker's income before taxes and is allowed to grow tax-deferred until the worker retires. IRA funds can be invested in a variety of ways, including stocks and bonds, money market accounts, treasury bills, mutual funds, and certificates of deposit. Intended to make it easier for individuals to save money for their own retirement, IRAs are nonetheless subject to a number of complex government regulations and restrictions. The amount of annual contributions permitted, and the tax deductibility thereof, is dependent on the individual worker's situation.

The main difference between IRAs and employer-sponsored retirement plans is that IRA fundsalthough held by a trust or annuityare under the complete discretion of the account holder as far as withdrawals and choice of investments. For this reason, IRAs are known as self-sponsored and self-directed retirement accounts. Even combination plans that allow employers to make contributions, like Simplified Employee Pension (SEP) IRAs, are considered self-sponsored since they require the employee to set up his or her own IRA account. A special provision of IRAs allows individuals to roll over funds from an employer-sponsored retirement plan to an IRA without penalty.

IRAs were authorized by Congress in 1974 as part of a broader effort to reform laws governing pensions. Recognizing that employers facing intense competition might decide to cut costs by reducing the retirement benefits provided to employeesand that government programs such as Social Security would not be enough to fill in the gapsCongress sought to encourage individual taxpayers to undertake long-term savings programs for their own retirement. The Internal Revenue Service responded by making provisions for individual retirement accounts in section 408 of the tax code. IRAs quickly became recognized as one of the most opportunistic and flexible retirement options available, enabling workers to control their own preparations for the conclusion of their working lives.

IRA PROVISIONS

In the original provisions, elective pre-tax contributions to IRAs were limited to $1,500 per year. The maximum annual contribution increased to $2,000 in 1982, but new restrictions were imposed upon workers who were covered under an employer's retirement plan. For example, such workers were not eligible to deduct their total IRA contributions unless their adjusted gross income was less than $25,000 if unmarried, or less than $40,000 if married. A partial deduction was available for single workers who earned up to $35,000 and married workers who earned up to $50,000, but no deductions were allowed for people with higher income levels. These restrictions did not apply to self-employed individuals and others who did not participate in an employer's plan. For tax year 2006, if you are covered by a retirement plan at work, your deduction for contributions to a traditional IRA will be phased out if your modified adjusted gross income is: 1) more than $75,000 but less than $85,000 for a married couple filing a joint return or a qualifying widow(er), or 2) more than $50,000 but less than $60,000 for a single individual or head of household, or 3) less than $10,000 for a married individual filing a separate return.

The way the tax code was written, individuals were intended to begin making regular withdrawals from their IRAs upon retirement. These withdrawals would be considered income and subjected to income tax, but the individual was presumed to be in a lower tax bracket by this time than they had been during their working years. "Ordinary" distributions from an IRA are those taken when a worker is between the ages of 59 1/2 and 70 1/2. Though workers are not required to begin receiving distributions until they reach age 70 1/2, most establish a regular schedule of distributions to supplement their income during this time.

The total annual distributions from an IRA cannot exceed $150,000 per year, or they are subject to a 15 percent penalty in addition to the regular income tax. "Early" withdrawals, or those taken before a worker reaches age 59 1/2, are subject to a 10 percent penalty on top of the regular income tax, except in cases of death or disability of the account holder. In addition, there are ten other reasons that the government will let you access the money, such as higher education expenses and first-time homeownership. The rules on such distributions are very rigid and one must carefully document any reasons for early withdrawal or face IRS penalties. The early distribution penalty is intended to discourage younger people from viewing an IRA as a tax-deferred savings account.

Legislation passed over the years since the IRA's initial authorization has refined the scope, provisions, and requirements of IRAs so that other forms are available besides the basic, individual "contributory" IRA. As outlined by W. Kent Moore in The Guide to Tax-Saving Investing, the different IRA variations include:

  1. Spousal IRAs, which enable a working spouse to contribute to an IRA opened for a nonworking partner
  2. Third-party-sponsored IRAs, which are used by employee organizations, labor unions, and others wishing to contribute on workers' behalf
  3. Simplified Employee Pensions (SEPs), which enable employers to provide retirement benefits by contributing to workers' IRAs
  4. Savings Incentive Match Plan for Employees (SIMPLE) IRAs, which require employers to match up to 3 percent of an employee's salary, or $6,000 annually, plus allow employees to contribute another $6,000 per year to their own accounts
  5. Rollover contribution accounts, which allow distributions from an IRA or an employer's qualified retirement plan to be reinvested in another IRA without penalty
  6. Roth IRAs, which enable single people with an annual income of less than $95,000 and married couples with an annual income of less than $150,000 to make a nondeductible contribution of $2,000 per year, whether they are covered by an employer's plan or not.

It is also possible for those earning less than $100,000 per year to convert a regular IRA to a Roth IRA by paying any deferred income tax. Though money placed in Roth IRAs is subject to taxes when invested, the earnings grow tax-deferred and the withdrawals are tax-free after five years.

FACTORS TO CONSIDER

Those interested in opening an IRA should familiarize themselves with the current regulations governing the amounts that may be contributed, the timing of contributions, the criteria for tax deductibility, and the penalties for making early withdrawals. They should also shop around when investigating financial institutions that offer IRAssuch as banks, credit unions, mutual funds, brokerage firms, and insurance companiesinasmuch as fees vary from institution to institution, ranging from no charge to a one-time fee for opening the account to an annual fee for maintaining the IRA. Financial institutions also differ in the amount of minimum investment, how often interest is compounded, and the type and frequency of account statement provided. There is no limit to the number of IRAs an individual can open, as long as he or she does not exceed the maximum allowable annual contribution.

Another important factor to consider, in addition to the trustee of the account, is where the IRA funds should be invested. Individuals have a wide range of investment options available to choose fromincluding bank accounts, certificates of deposit, stocks, bonds, annuities, mutual funds, or a combination thereofeach offering different levels of risk and rates of growth. According to many investment advisors, the ideal IRA investment is one that is reasonably stable, can be held for the long term, and provides a level of comfort for the individual investor. Most financial advisors advise against playing the stock market or investing in a single security with funds that have been earmarked for retirement, due to the risk involved. Instead, they recommend that individuals take a more diversified approach with their IRAs, such as investing in a growth-income mutual fund, in order to protect themselves against inflation and the inevitable swings of the stock market.

The decision about where IRA funds should be invested can be changed at any time, as often as the individual deems necessary. Switching to a different type of investment or to a mutual fund with a different objective usually only requires filling out a transfer form from the sponsoring financial institution. Since the IRA simply changes custodians in this type of transaction, and never passes through the hands of the individual investor, it is not subject to any sort of penalty or tax, and it is not considered a rollover.

Despite the number of decisions involved, IRAs nonetheless provide an important means for people to save for their retirement. "The advantages of IRAs far outweigh the disadvantages," as Moore noted. "Earnings for either deductible or nondeductible IRAs grow faster than ordinary savings accounts, because IRA earnings are tax deferred, allowing all earnings to be reinvested. Even when withdrawals are made, the remaining funds continue to grow as tax-deferred assets."

see also 401(k) Plans; Retirement Planning

BIBLIOGRAPHY

Blakely, Stephen. "Pension Power." Nation's Business. July 1997.

Crouch, Holmes F. Decisions When Retiring. Allyear Tax Guides, 1995.

"Deduction Phaseout for Regular IRAs Begins at Higher Levels in 2006." The Kiplinger Tax Letter 30 December 2005.

Internal Revenue Service. "What's New in 2006." Available from http://www.irs.gov/publications/p590/ar01.html. Retrieved on 14 March 2006.

Korn, Donald Jay. "Tax-Deferred Vehicles That Will Last a Lifetime." Black Enterprise. October 2000.

Moore, W. Kent. "Deferring Taxes with Retirement Accounts." The Guide to Tax-Saving Investing Globe Pequot Press, 1995.

Wiener, Leonard. "How to Keep One Step Ahead: Hot Tips for Turning an Annual Chore into Many Happy Returns." U.S. News and World Report. 9 March 1998.

Wiener, Leonard. "How to Unscramble a Nest Egg." U.S. News & World Report. 5 July 1999.

                                Hillstrom, Northern Lights

                                  updated by Magee, ECDI

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Individual Retirement Account

INDIVIDUAL RETIREMENT ACCOUNT

A means by which an individual can receive certain federal tax advantages while investing for retirement.

The federal government has several reasons for encouraging individuals to save money for their retirement. For one, the average life span of a U.S. citizen continues to increase. Assuming that the average age of retirement does not change, workers who retire face more years of retirement and more years to live without a wage or salary.

Uncertainty over the future of the federal

social security system is another reason. U.S. workers generally contribute deductions from their paychecks to the Social Security fund. In theory, this money will come back to them, usually upon their retirement. But a substantial number of politicians, economists, and scholars contend that the Social Security fund is being drained faster than it is being filled, and that it will go broke in a number of years, leaving retirees to survive without government assistance.

Regardless of its future, many people consider the retirement benefits of Social Security to be inadequate, and they look for other methods of funding their retirement years. Many employers offer retirement plans. These plans vary in form but generally offer retirement funds that grow with continued employment. Yet this benefit is not always available to workers. A changing economy has caused some employers to cut back on retirement plans or to cut them out

completely. Often, part-time, new, or temporary workers do not qualify for an employer's retirement plan. And individuals who are self-employed may not choose this job benefit.

To help people prepare for their retirement, Congress in 1974 established individual retirement accounts (IRAs) (employee retirement income security act [ERISA] [codified in scattered sections of 5, 18, 26, and 29 U.S.C.A.]). These accounts may take a variety of forms, such as savings accounts at a bank, certificates of deposit, or mutual funds of stocks. Initially, IRAs were available only to people who were not participating in an employer-provided retirement plan. This changed in 1981, when Congress expanded the IRA provisions to include anyone, regardless of participation in an employer's retirement plan (Economic Recovery Tax Act [ERTA] [codified in scattered sections of 26, 42, and 45 U.S.C.A.]). The goal of ERTA was

to promote an increased level of personal retire ment savings through uniform discretionary savings arrangements.

A movement to bolster the federal budget by eliminating many existing tax shelters prompted portions of the tax reform act of 1986 (codified in scattered sections of 19, 25, 26, 28, 29, 42, 46, and 49 U.S.C.A.) and another change in IRA laws. This time, Congress limited some of the IRA's tax advantages, making them unavailable to workers who participate in an employer's retirement plan or whose earnings meet or exceed a certain threshold. Yet, other tax advantages remain, and the laws still allow any one to contribute to an IRA, making it a popular investment tool.

It is difficult to understand the advantages that an IRA offers without understanding a few basics about federal income tax law. Generally, a person calculating the amount of tax that he or she owes to the government first determines the amount of income received in the year. This is normally employment income. Tax laws allow the individual to deduct from this figure amounts paid for certain items, such as charitable contributions or interest on a mortgage. Some taxpayers choose to take a single standard deduction rather than numerous itemized deductions. In either case, the taxpayer subtracts any allowable deductions from yearly income and then calculates the tax owed on the remainder.

Taking deductions is only one of the ways in which a taxpayer may reduce taxes by investing in an IRA. But IRAs have proven to be popular with taxpayers. This popularity has prompted expansion of the federal tax rules to encourage additional savings and investment through IRAs. In 2003 there were 11 types of IRAs:

  1. Individual Retirement Account
  2. Individual Retirement Annuity
  3. Employer and Employee Association Trust Account
  4. Simplified Employee Pension (SEP-IRA)
  5. Savings Incentive Match Plan for Employees IRA (SIMPLE IRA)
  6. Spousal IRA
  7. Rollover IRA (Conduit IRA)
  8. Inherited IRA
  9. Education IRA
  10. Traditional IRA
  11. Roth IRA

Despite the many variations, the two most important remain the traditional IRA and the Roth IRA.

In traditional IRAs, a single filer may deduct IRA contributions as long as his or her income is less than $95,000 (to qualify for a full contribution) or $95,000-$110,000 to qualify for a partial contribution. Joint filers may deduct IRA contributions as long as their adjusted gross income is less than $150,000 (to qualify for a full contribution). If their adjusted gross income is between $150,000 and $160,000, they may qualify for a partial contribution.

IRA contribution limits increased in 2002 and will increase over the next few years. For individual taxpayers, contributions are limited to $3,000 for tax years 2003 and 2004. In tax years 2005 through 2007, contributions are capped at $4,000. They are eventually capped at $5,000 for individual taxpayers in 2008 through 2010.

Various plans may constitute employer-maintained retirement plans, such as standard pension plans, profit-sharing or stock-bonus plans, annuities, and government retirement plans. Someone who does not participate in such a plan—whether by choice or not—is entitled to contribute to an IRA up to $3,000 a year or 100 percent of her or his annual income, whichever is less. The amount contributed during the taxable year may then be taken as a deduction.

A married taxpayer who files a joint tax return with a spouse who does not work may deduct contributions toward what is called a spousal IRA, or an IRA established for the spouse's benefit. If neither spouse is a participant in an employer-provided retirement plan, up to $4,000 may be deductible.

Taxpayers who contribute to Traditional IRAs usually realize tax benefits even when the law does not permit them to take deductions. That is because income earned on Traditional IRA contributions is not taxed until the funds are distributed, which usually occurs at retirement. Income that is allowed to grow, untaxed, for several years, grows faster than income that is taxed each year.

To avoid abuses and excessive tax shelters, Congress has placed limits on the extent to which IRAs can be used as a financial tool. Individuals with IRAs may currently make contributions limited to $3,000 a year; contributions exceeding that amount are subject to strict financial penalties by the internal revenue service each year until the excess is corrected. The owner of an IRA generally may not withdraw funds from that account until age 591/2. Premature distributions are subject to a ten percent penalty in addition to regular income tax. Taxpayers may be able to avoid this premature distribution penalty by "rolling over," or transferring, the distribution amount to another IRA within 60 days.

An individual may elect not to withdraw IRA funds at age 591/2. However, the law requires IRA owners to withdraw IRA money at age 701/2, either in a lump sum or in periodic (at least annual) payments based on a life-expectancy calculation. Failure to comply with this rule can result in a 50 percent penalty on the amount of the required minimum distribution. Contributions to an IRA must stop at age 701/2.

In 1997, Congress provided for a new type of IRA—the Roth IRA, named for former Senator William V. Roth, Jr. The Roth IRA was part of the Taxpayer Relief Act of 1997, Pub.L. No. 105-34, 111 Stat. 788 (codified as amended in scattered sections of 26 U.S.C.). Contributions to a Roth IRA are not deductible from gross income, and the Roth IRA allows no deductions for contributions. Instead, Roth IRAs provide a benefit that is unique among retirement savings schemes: If a taxpayer meets certain requirements, all earnings from the IRA are tax-free when the taxpayer or his or her beneficiary withdraws them. There are other benefits as well, such as no early distribution penalty on certain withdrawals, and no need to take minimum distributions after age 701/2.

The chief advantage of the Roth IRA is the ability to have investment earnings escape taxation. However, taxpayers may not claim a deduction when they contribute to Roth IRAs. Whether it is more advantageous to use Roth IRAs or traditional IRAs depends on each taxpayer's personal situation. It also depends on what assumptions the taxpayer makes about the future, such as future tax rates and the taxpayer's earnings in the interim.

One may open a Roth IRA if he or she is eligible for a regular contribution to a Roth IRA or a rollover or conversion to a Roth IRA. A taxpayer is eligible to make a regular contribution to a Roth IRA even if he or she participates in a retirement plan maintained by his or her employer. These contributions may be as much as $3,000 ($3,500 if 50 or older by the end of the year). There are just two requirements: the taxpayer or taxpayer's spouse must have compensation or alimony income equal to the amount contributed; and the taxpayer's modified adjusted gross income may not exceed certain limits. These limits are the same as in traditional IRAs: $95,000 for single individuals and $150,000 for married individuals filing joint returns. The amount that a taxpayer may contribute is reduced gradually and then completely eliminated when the taxpayer's modified adjusted gross income exceeds $110,000 (single) or $160,000 (married filing jointly).

A traditional IRA may be converted to a Roth IRA if modified adjusted gross income is $100,000 or less, and if the taxpayer is either single or files jointly with his or her spouse. Although taxpayers converting traditional IRAs to Roth IRAs must pay tax in the year of the conversion, the long-term savings often greatly out-weigh the conversion tax.

further readings

Boes, Richard F., and G. Michael Ransom. 1994."Untangling the IRA Rules." Tax Adviser 25 (August 1).

J.K. Lasser Institute. 1996. J.K. Lasser's Your Income Tax 1996. New York: Macmillan.

Kaster, Nicholas. 1998. Roth IRAs after 1998 Tax Law Changes. Chicago: CCH.

Levy, Donald R., and Avery E. Neumark. 2000. Quick Reference to IRAs, 1999. New York: Panel Publishers.

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Individual Retirement Account

INDIVIDUAL RETIREMENT ACCOUNT

INDIVIDUAL RETIREMENT ACCOUNT, or IRA, was created in 1974 for those individuals not covered by company pensions. Initially individuals could make tax-deductible contributions of up to $1,500 per annum to an IRA account, but in 1981, a new tax law allowed individuals to make tax-deductible contributions up to $2,000 per annum; the sum was raised to $3,000 for tax year 2002. The Taxpayer Relief Act of 1997 gave employees already in corporate pension programs the ability to contribute monies to their own IRA accounts. IRA contributions can be placed in high-yield investments, with taxation deferred until the money is withdrawn. In most cases, IRA contributions cannot be withdrawn without penalty until after age fifty-nine and a half. Congress did make some exceptions to the rule, however, for qualified education expenses through the creation of an Education IRA and for first-time home purchases. The Taxpayer Relief Act also created the Roth IRA, in which the earnings are tax-free, but there are no tax-deduction benefits for the contributions made each year. Contributions to a Roth IRA are made with after-tax rather than pre-tax dollars, but earnings are tax-free. If certain conditions are met, the earnings are free of Internal Revenue Service penalties. Unlike a traditional IRA, Roth contributions are allowed beyond age seventy and a half.

BIBLIOGRAPHY

Bamford, Janet, et al. The Consumer Reports Money Book: How to Get It, Save It, and Spend It Wisely. Yonkers, N.Y.: Consumer Reports, 2000.

Downing, Neil. The New IRAs and How to Make Them Work for You. Chicago: Dearborn Trade, 2002.

Meg GreeneMalvasi

See alsoRetirement Plans .

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Individual Retirement Account

Individual Retirement Account (IRA), tax-sheltered retirement plan, originally created (1974) to assist individuals not covered by company pensions. Under the U.S. tax law of 1981, IRA provisions were liberalized to allow individuals to contribute up to $2,000 per year (up from $1,500) to such accounts, and coverage was extended to employees already in corporate pension programs. These contributions are deductible from federal income tax payments. IRA monies may be placed in high-yield investments, with taxation deferred until money is withdrawn after retirement. In 1998, Congress instituted the Roth IRA, in which the earnings are tax-free but there are no tax-deduction benefits for the contributions made each year.

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IRA

IRA • abbr. ∎  (often / ˈīrə/ ) individual retirement account. ∎  Irish Republican Army.

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IRA (abbreviation)

IRA:1 In Irish history, see Irish Republican Army. 2 In economics, see Individual Retirement Account.

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IRA

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IRAS

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IRA

IRA (USA) individual retirement account
• Institute of Registered Architects
• Irish Republican Army

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FRAN ALEXANDER , PETER BLAIR , JOHN DAINTITH , ALICE GRANDISON , VALERIE ILLINGWORTH , ELIZABETH MARTIN , ANNE STIBBS , JUDY PEARSALL , and SARA TULLOCH. "IRA." The Oxford Dictionary of Abbreviations. 1998. Encyclopedia.com. 25 Sep. 2016 <http://www.encyclopedia.com>.

FRAN ALEXANDER , PETER BLAIR , JOHN DAINTITH , ALICE GRANDISON , VALERIE ILLINGWORTH , ELIZABETH MARTIN , ANNE STIBBS , JUDY PEARSALL , and SARA TULLOCH. "IRA." The Oxford Dictionary of Abbreviations. 1998. Encyclopedia.com. (September 25, 2016). http://www.encyclopedia.com/doc/1O25-IRA.html

FRAN ALEXANDER , PETER BLAIR , JOHN DAINTITH , ALICE GRANDISON , VALERIE ILLINGWORTH , ELIZABETH MARTIN , ANNE STIBBS , JUDY PEARSALL , and SARA TULLOCH. "IRA." The Oxford Dictionary of Abbreviations. 1998. Retrieved September 25, 2016 from Encyclopedia.com: http://www.encyclopedia.com/doc/1O25-IRA.html

IRAS

IRAS (ˈaɪræs) Infrared Astronomical Satellite

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