IRS regulations allow you to take advantage of other personally established, selfdirected tax-sheltered retirement accounts. These are especially important if your employer offers no retirement plan. But even if you do have a plan at work, you can benefit from personally established plans.
Individual Retirement Accounts
An individual retirement account (IRA) is a personal retirement account to which a person can make annual contributions. These accounts are created and funded at the discretion of the individual who sets them up. An IRA is much like any other account opened at a bank, credit union, brokerage firm, or mutual fund company. An IRA is not an investment but rather an account in which to hold investments, such as stocks and mutual funds. You can invest IRA money almost any way you desire, including collectibles like art, gems, stamps, antiques, rugs, metals, guns, and certain coins and metals. You may change investments whenever you please. You should consider investing in an IRA to augment your retirement savings. IRAs are similar to 401(k) plans in that you do not pay taxes each year on capital gains, dividends, and other distributions from securities held within the account. The maximum contribution you may make to an IRA is $5000. An additional catch-up contribution of $1000 to an IRA may be made by people age 50 and older. You may not borrow from an IRA. To fund the account, you may make a new contribution or transfer a lump-sum distribution received from another employer plan or another IRA account to your IRA account. Taxpayers can even opt on their tax return to allocate part or all of their refund for direct deposit into an IRA account.
Individual Retirement Accounts
An individual retirement account (IRA) is a personal retirement account to which a person can make annual contributions. These accounts are created and funded at the discretion of the individual who sets them up. An IRA is much like any other account opened at a bank, credit union, brokerage firm, or mutual fund company. An IRA is not an investment but rather an account in which to hold investments, such as stocks and mutual funds. You can invest IRA money almost any way you desire, including collectibles like art, gems, stamps, antiques, rugs, metals, guns, and certain coins and metals. You may change investments whenever you please. You should consider investing in an IRA to augment your retirement savings. IRAs are similar to 401(k) plans in that you do not pay taxes each year on capital gains, dividends, and other distributions from securities held within the account. The maximum contribution you may make to an IRA is $5000. An additional catch-up contribution of $1000 to an IRA may be made by people age 50 and older. You may not borrow from an IRA. To fund the account, you may make a new contribution or transfer a lump-sum distribution received from another employer plan or another IRA account to your IRA account. Taxpayers can even opt on their tax return to allocate part or all of their refund for direct deposit into an IRA account.
Traditional IRAs A traditional (or regular) IRA offers tax-deferred growth. Your contributions may be tax deductible, which means that you can use all or part of your contributions to reduce your taxable income. Qualifying depends on how much your earnings are (restrictions exist to prevent some high-income earners from getting the deduction) and whether you and your spouse are eligible to participate in an employer-sponsored retirement plan. To see whether you qualify for a taxdeductible IRA, use the following guidelines:
- If you have no retirement plan at work, you can invest in a traditional IRA and deduct the entire amount from your taxes.
- If you are married and you are not an active participant in an employer retirement plan but your spouse is an active participant, you may deduct all of your contribution to a traditional IRA.
- If you have a retirement plan at work, you may fully or partially deduct your IRA contribution only if your adjusted gross income qualifies. Also, if either spouse participates in an employer-sponsored retirement plan, the allowable contribution depends on the couple’s income. The amount begins to be reduced for single taxpayers earning about $80,000 and $160,000 for joint returns.\
- If you have a nonworking spouse, that person may contribute to a spousal IRA. Each partner may invest up to the limit and deduct the full amount if the combined compensation of both spouses is at least equal to the contributed amount.
Distributions from traditional IRAs may be fully or partially taxable. If the account is funded solely by tax-deductible contributions, any distributions are fully taxable when received. If you also made nondeductible contributions, logically some amount should not be taxed at withdrawal as it has already been taxed earlier. You should maintain adequate records of all IRA contributions even for 40 years or more to avoid paying too much in taxes. That means saving all annual reports of account activities. The IRS requires that withdrawals from traditional IRAs begin no later than age 701⁄2.
Roth IRAs A Roth IRA is a nondeductible, after-tax IRA that offers significant tax and retirement planning advantages for taxpayers earning less than approximately $110,000. Contributions of up to $5000 annually to Roth IRAs are not tax deductible and funds in the account grow tax free. Once you remove money from a Roth IRA, it is a withdrawal (not a loan), and you cannot put it back. Tax-free and penalty-free withdrawals of earnings may be made after a five-year waiting period if you are older than age 591⁄2 or you are disabled. Tax-free withdrawals may be made for qualifying first-time home-buyer expenses or to pay for educational expenses. There is no mandatory withdrawal schedule for Roth IRAs, and money in the account can pass to an heir free of estate taxes. A traditional IRA may be converted to a Roth IRA.*
Keoghs and SEP-IRAs
A Keogh (pronounced “Key-oh”) is a tax-deferred retirement account designed for self-employed and small-business owners. Depending on the type of Keogh established (profit-sharing or money-purchase), an individual can save as much as 25 percent of self-employment earned income, with most plan contributions capped at $45,000 per participant. If the income comes from self-employment, contributions can still be made after age 701⁄2. Money in Keoghs may be invested in real estate, and a Keogh can be converted to a SEP-IRA. A simplified employee pension–individual retirement account (SEP-IRA) is intended for taxpayers with self-employment income and owners of small businesses. A SEP-IRA is easier to set up and maintain than a Keogh. The maximum contribution limit to a SEP-IRA is the same as for a Keogh. People with income from a sideline business can contribute substantial amounts to a SEP-IRA account. There also is a one-person 401(k) plan, which allows larger contributions than a Keogh or SEP-IRA plan.
Roth IRAs A Roth IRA is a nondeductible, after-tax IRA that offers significant tax and retirement planning advantages for taxpayers earning less than approximately $110,000. Contributions of up to $5000 annually to Roth IRAs are not tax deductible and funds in the account grow tax free. Once you remove money from a Roth IRA, it is a withdrawal (not a loan), and you cannot put it back. Tax-free and penalty-free withdrawals of earnings may be made after a five-year waiting period if you are older than age 591⁄2 or you are disabled. Tax-free withdrawals may be made for qualifying first-time home-buyer expenses or to pay for educational expenses. There is no mandatory withdrawal schedule for Roth IRAs, and money in the account can pass to an heir free of estate taxes. A traditional IRA may be converted to a Roth IRA.*
Keoghs and SEP-IRAs
A Keogh (pronounced “Key-oh”) is a tax-deferred retirement account designed for self-employed and small-business owners. Depending on the type of Keogh established (profit-sharing or money-purchase), an individual can save as much as 25 percent of self-employment earned income, with most plan contributions capped at $45,000 per participant. If the income comes from self-employment, contributions can still be made after age 701⁄2. Money in Keoghs may be invested in real estate, and a Keogh can be converted to a SEP-IRA. A simplified employee pension–individual retirement account (SEP-IRA) is intended for taxpayers with self-employment income and owners of small businesses. A SEP-IRA is easier to set up and maintain than a Keogh. The maximum contribution limit to a SEP-IRA is the same as for a Keogh. People with income from a sideline business can contribute substantial amounts to a SEP-IRA account. There also is a one-person 401(k) plan, which allows larger contributions than a Keogh or SEP-IRA plan.
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