An Individual Retirement Account, or IRA, is a retirement plan that provides tax advantages for retirement savings within United States tax law. Unlike 401k plans, which must be provided by an employer, IRAs can also be created by an individual. Aside from one specific type, IRAs contributions are made before tax.
Types of Individual Retirement Accounts
Different types of IRAs work in different ways. Traditional IRAs have no real distinguishing characteristics. Roth IRAs are perhaps the most different in intent, as the funds are taxed before contribution, allowing tax free withdrawals later in life.
Other types of IRAs include SEP IRAs, which are generally used by small businesses or self-employed individuals, SIMPLE IRAs, which are similar to simplified 401k plans with low contribution limits and simple administration, and Self-Directed IRAs, which are managed by the holder, rather than a designated custodian.
Though there were once several other types of IRAs, these forms are now obsolete. These eliminated forms include Rollover, conduit, and Educational IRAs.
Despite their differences, the tax treatments required for IRAs are very similar. The only major difference is for Roth IRAs, which are taxed at withdrawal instead of deposit.
Paying into IRAs
Only cash can be contributed to IRAs. As of 2008, the contribution limit for IRAs is $5000 per year, or $6000 if the individual is 50 years of age or older. However, contributions cannot be more than the annual income of the holder.
As a general rule, money can be transfered freely between IRAs and other retirement accounts, though there are a few unusual exceptions to this rule.
Distributions
Generally there are strong penalties for withdrawing funds from retirement plans with tax benefits, and IRAs are no exception. In this case, funds cannot be withdrawn without significant penalties before the holder reaches the age of 59 and 1/2. Exceptions allowing withdrawals include educational expenses, if the holder becomes disabled, or the first time the holder buys a house.
In addition, withdrawals must be made after the holder reaches the age of 70 and 1/2 years, or half the money that should have been distributed will be lost.
Direction
With the exception of Self-Directed IRAs, IRAs are generally managed by designated managers. IRAs are usually composed of securities. Some other assets are often allowed, but many managers discourage their inclusion.
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