Retirement age will come sooner than we think. For this reason, we need to start thinking and saving now for that future time. Many people are investing in IRA’s for their future retirement needs. But do you know exactly what an IRA is?
IRA stands for an INDIVIDUAL RETIREMENT ACCOUNT. This is a savings account that has the sole purpose of being used for ones retirement. Having an account like this has income tax advantages, too.
The money you put into your IRA is called a contribution. This contribution as well as all earnings and gains from the total contribution for each tax year may be tax free, as long as you do not withdraw any of this money. This means you can accumulate more money into your IRA each year.
When you do withdraw any money from your IRA it is called a distribution. This distribution is then subject to taxable income for that tax year. You are also faced with a penalty if you take any distributions out of your IRA before it matures. The penalty is usually 10% of the distribution you make.
You can begin making distributions from your IRA at the age of 59 and 1/2 without facing penalties. You must start making some distributions no later than April 1 of the following year of your 70 and 1/2 birthday or you again will be facing penalties.
There are five different kinds of IRA’s.
1. The Traditional IRA.
You can contribute up to $2,000 a year with a traditional IRA. The amount you can deduct will depend on whether you are covered under an employer retirement plan and if you are filing single, married, etc.
2. An education IRA
This is not a very popular IRA. With this IRA, you can contribute up to $500 yearly and it is completely tax-free. But the rules are complicated. The beneficiary must use it for the sole purpose of education.
3. Simplified Employee Pension (Simplified IRA).
This is an IRA that a lot of sole proprietors use for their own retirement. This is employer established and funded. An employer would put in 15% of his/her employees compensation into this IRA.
4. Simple IRA
This is a new IRA that is becoming popular. It is also an employer funded IRA. But with this IRA, the employee can contribute up $6,500 tax free, each year.
5. Roth IRA
With the Roth IRA the contributions are not deductible. But the earnings are tax-free. To be eligible for a Roth IRA one’s adjusted gross income must be under $95,000 if one is single and under $150,000 if married. You also can not make any withdraws from a Roth IRA within the first 5 years, without facing a penalty.
Who can establish an IRA? Anyone who has taxable income and who is under the age of 70 and 1/2 years of age can open an IRA. You can open an IRA at many banks, at some insurance companies and at some stock brokerage firms.
You can also establish your IRA to be left to your spouse or your estate upon your death. It will, of course, be taxed as income. First, it will be taxed as part of your federal gross estate tax. Then it will be taxed as an ordinary taxable income to the ultimate beneficiary.
If you set up an IRA be warned that you can never borrow against these funds.
Could an IRA be right for your retirement needs? It depends on how much you have to save each year, how much of a tax break you need and what you think your future needs are. Each person has different needs. If you can, you may want to talk to a financial advisor about your specific needs.