What is an IRA, Individaul Retirement Account/Annuity....

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What is an IRA, Individual Retirement Account/Annuity....

An IRA is a retirement investing tool that can be either an Individual Retirement Account or an Individual Retirement Annuity.<

Both Traditional and Roth are established by individual taxpayers, who are allowed to contribute 100% of compensation (Self-employment income for Sole proprietors and partners) up to a specified maximum dollar amount. Contributions to the Traditional one may be tax-deductible depending on the taxpayer's income, tax-filing status, and coverage by an employer-sponsored retirement plan. Roth IRA contributions are not tax-deductible.

SEPs and SIMPLEs are retirement plans established by employers. Individual participant's contributions are made to SEP IRAs and SIMPLE IRAs.

An Individual Retirement Account is a personal savings plan that allows you to contribute up to $3,000 a year! (If you're 50 or older, you can make an additional $500 "catch-up" contribution.) Well, that's nice and all, but what's really in it for you?

You Keep More Money: An IRA is a (legal!) way for you to keep more of your money from Uncle Sam. And it's possible you have a delightful choice: Do you want to save on taxes now with a traditional IRA or when you retire with a Roth IRA?

You'll Have a Rosier (and More Flush) Future: Every dollar you invest today will work for you until that glorious day when you stop working. The sooner you open an IRA, the more money you'll have for your golden years.

Why You Should Open an IRA Now: You have until April 15, 2003, to make a contribution to your IRA for 2002. So it's not too late... yet.

It's Easy to Open an IRA: All you have to do is follow these steps to get started saving now and for your future.

Are you self-employed or employed by someone else in an activity for which you receive earned income or compensation? If so, then you are eligible to make a contribution to either a traditional or a Roth IRA. Cue the marching band!

Traditional IRA Eligibility If you have earned income and are under age 70 1/2, then you may make a contribution to a traditional IRA. The only question is whether that contribution will be deductible. That depends on your income tax filing status and whether you (or your spouse) participated on any day in the year in an employer's qualified retirement plan.

In general, if neither you nor your spouse participated in a 401(k) or other qualified retirement plan, your contribution will be fully deductible.

If you (or your spouse) did participate in an employer-sponsored retirement plan, then your contribution to a traditional IRA might be deductible, depending on your modified adjusted gross income (AGI). (Modified AGI for most folks is the same as the adjusted gross income on the last line of the first page of Form 1040.) The amount of a traditional IRA contribution that is deductible declines to zero between certain AGI ranges, as follows:

For 2002 Contributions

$0 to $10,000 for married couples filing separately $34,000 to $44,000 for single or head of household filers $54,000 to $64,000 for joint filers $150,000 to $160,000 if you didn't participate in a qualified retirement plan, but your spouse did (and you're filing jointly) Example: If you're single and your AGI for 2002 was $34,000, you would be able to fully deduct your IRA contribution. If your AGI was $40,000, you would be able to deduct part of your contribution. If your AGI was $44,000 or higher, you would not be able to deduct your contribution at all.

Roth IRA Eligibility If you have earned income, then regardless of your age you may contribute to a Roth IRA provided your modified AGI doesn't exceed certain limits. If you're a single filer, then you can make a full contribution to a Roth if your modified AGI is less than $95,000. You may make a partial contribution to a Roth when your modified AGI is between $95,000 and $110,000. But when your modified AGI reaches $110,000, you're no longer eligible.

The phase-out range for a Roth IRA contribution for a married couple filing a joint return is $150,000 to $160,000. For a married person filing separately, the phase-out range is $0 to $10,000.

Eligible for both a Roth and a traditional IRA? Then you've got a choice to make. Let's weigh your options next.

It's really quite simple to open an IRA account -- easy as 1-2-3, as a matter of fact.

Step 1: Find a Discount Broker If you don't already have one, we suggest that you look into opening a discount brokerage account. In selecting a broker, there are a couple of things to consider:

Pay Attention to Fees. By law, an IRA trustee (which is what your broker will be) can charge an annual fee to maintain your IRA. Many charge around $30 a year to maintain an IRA, but some do not charge anything (which sounds pretty good to us Fools).

Consider Trading Commissions. How much are you paying each time you buy or sell a stock? Even if you employ a long-term buy-and-hold strategy, you've still got to fund your account. Make sure the bulk of your contribution is going toward your retirement nest egg, not commissions.

The reason for such a parsimonious attitude toward your IRA account is that your contributions are limited to $3,000 in 2002. An extra $50 a year in transaction fees will, over time, reduce your account balance by thousands of dollars.

In other words, it pays to shop around. In retirement those fees could mean the difference between serving festive drinks on your beachfront property in Tahiti, or sipping generic beer at your timeshare in Toledo.

For those eager to start saving for their slice of retirement paradise right now, we've put together the following table that compares the IRA offerings of the brokers who appear in our Discount Brokerage Center. Compare their fees and services. And if you find a broker that looks good to you, go ahead and open an account or get more information!

roth v normal

So let's say you're eligible for both a traditional IRA and a Roth IRA. Which should you choose?

Choose a Roth IRA if you can do without the tax break right now. It's a more flexible instrument, because:

It allows you to withdraw your contributions at any time, penalty- and tax-free. You do not have to take mandatory distributions at age 70 1/2. Choose a traditional IRA if you need that tax deduction right now, or you anticipate paying taxes at a significantly lower rate in retirement.

We should also point out that there is a traditional nondeductible IRA, but you won't realize tax benefits comparable to those available through Roth or traditional tax-deductible IRAs. However, if your income prohibits you from making contributions to the other IRAs, a traditional nondeductible IRA is still attractive because of the tax-deferred growth.

Once you've solved the "traditional vs. Roth" dilemma, there's just one thing left to do: Open an account.

If you want to find out even more on the whys and wherefores of Roth versus traditional IRAs, we have an entire IRA area at your disposal.

all about

The Individual Retirement Account (IRA) brings together two tremendously powerful forces, both of which benefit you: 1) compound interest, and 2) tax savings.

If you've got money that you can afford to invest for the long term, there's really no reason not to open an IRA. Lethargy is not a good reason. Inertia is not a good reason. Keeping your eyes wide shut about your future is not a good reason. Compound interest becomes even more powerful when it is not held back by the drag coefficient of taxes.

In those golden years, you want to be able to go out and buy the gold-plated golf clubs, jet out to Hawaii to circle the big island on a dolphin's back, savor the flavor of fine French food, make generous contributions to a cause that stirs your passions, or hire a trainer to help you get in shape for your Space Shuttle mission. You also want the opportunity to become your family's Most Beloved Ancestor -- the more you save, and the more you have at the end of the day, the more you're likely to have left over to spread around to your heirs. So you're really doing everyone a favor -- yourself included.

The language of IRAs is often clouded with terms like "AGI" and "minimum distributions" and "rollovers." Yes, you'll find those self-same terms here, but we'll do our best to make it all meaningful and digestible. To that end we've added a little glossary to have as a handy reference.

So, here we present most everything you'd like to know about IRAs. Your mouth will drop open in glad delirium as you learn that there are actually 11 (count 'em, 11!) types of IRAs. You'll find out about the eight exceptions to the 10% penalty. You'll journey through the land of Roth, and determine whether you should take advantage of the IRA that carries its name. (Hey! This is starting to sound like an epic!) You'll learn about Education IRAs, contribution/deduction limits, and rollovers.

Here we've gathered together the far-flung strands of IRA trivia in Fooldom, and arranged them in one easy-to-use, easy-to-print collection.

Adjust your screen for maximum viewing pleasure -- fire up the printer, if you so choose -- and read on!

By Dave Braze (TMF Pixy)

What is an IRA, anyhow? An Individual Retirement Arrangement (IRA), commonly called an Individual Retirement Account, is a personal retirement savings plan available to anyone who receives taxable compensation during the year. For IRA contribution purposes, compensation includes wages, salaries, fees, tips, bonuses, commissions, taxable alimony, and separate maintenance payments.

Husbands and wives may each have an IRA, even if one person in that marriage is not working. One person's annual contribution, whether made to just one or to multiple IRAs, is limited to the lesser of total taxable compensation or to the normal yearly amount shown in the following table. Persons age 50 or older may make an additional catch-up contribution in the amount indicated in the table below.

Traditional and Roth IRA Annual Contribution Limits

Year Normal Catch-up ---------------------------- 2001 $2,000 $0 2002 $3,000 $500 2003 $3,000 $500 2004 $3,000 $500 2005 $4,000 $500 2006 $4,000 $1,000 2007 $4,000 $1,000 2008 $5,000 $1,000 2009+ Indexed* $1,000 *Normal contribution limits will increase annually by $500 whenever cumulative inflation exceeds the next higher $500 increment.

There is no minimum or required IRA contribution, and all earnings on the amounts in an IRA are untaxed until withdrawn. In the case of the Roth IRA, withdrawals may even be tax-free provided certain minimum rules discussed later are met.

Contributions to a Roth IRA are never tax-deductible. Contributions to a traditional IRA may or may not be deductible in the tax year made, depending on the owner's income tax filing status, adjusted gross income (AGI), and eligibility to participate in a tax-qualified retirement plan through employment. If the traditional IRA owner participates in an employer's qualified retirement plan on any day in the tax year, the deductibility of contributions declines to zero between certain AGI ranges as shown in the following table.

AGI Phase-Out Limits for Deductible Traditional IRA

Year Single Filer Joint Filer -------------------------------------------- 2001 $33,000 - $43,000 $53,000 - $63,000 2002 $34,000 - $44,000 $54,000 - $64,000 2003 $40,000 - $50,000 $60,000 - $70,000 2004 $45,000 - $55,000 $65,000 - $75,000 2005 $50,000 - $60,000 $70,000 - $80,000 2006 $50,000 - $60,000 $75,000 - $85,000 2007* $50,000 - $60,000 $80,000 - $100,000 * 2007 and later

A working spouse not covered by a retirement plan through employment may make a tax-deductible contribution of up to $2,000 annually to an IRA despite the other spouse's coverage under an employer-provided retirement plan. When the couple's AGI reaches $150,000, deductibility for such contributions begins to decline, and it reaches zero at a joint AGI of $160,000.

Money may be withdrawn from an IRA at any time, but on withdrawal it may be taxed and/or penalized. Withdrawals from a traditional IRA will always be taxed, either in whole or in part, at ordinary income tax rates. Except as noted below, withdrawals from a traditional IRA prior to age 59 1/2 will result in a 10% excise tax as well as an ordinary income tax. The potential income taxes and early withdrawal penalties on Roth and Education IRA withdrawals will be discussed in subsequent articles.

If nondeductible contributions were made to a traditional IRA, part of any withdrawal from that IRA will not be taxed. The calculations for deriving the taxable and nontaxable part of the withdrawal are too complicated to cover here. For those who may face this problem, the IRS has a handy-dandy way to make that calculation. It's called Form 8606, a tax document that must be completed and filed with your income tax return to report both nondeductible traditional IRA contributions and withdrawals whenever they occur.

Mandatory distributions for traditional IRAs must begin no later than April 1 of the year following the year the IRA owner reaches age 70 1/2. Failure to take required minimum distributions at that age results in a 50% excise tax on the amounts not distributed. Roth IRAs have no mandatory distribution requirement, but Education IRAs do as discussed here.

There are eight exceptions to the 10% penalty for IRA withdrawals prior to age 59 1/2. The early withdrawal penalty does not apply to distributions that:

Occur because of the IRA owner's disability. Occur because of the IRA owner's death. Are a series of "substantially equal periodic payments" made over the life expectancy of the IRA owner. Are used to pay for unreimbursed medical expenses that exceed 7 1/2% of adjusted gross income (AGI). Are used to pay medical insurance premiums after the IRA owner has received unemployment compensation for more than 12 weeks. Are used to pay the costs of a first-time home purchase (subject to a lifetime limit of $10,000). Are used to pay for the qualified expenses of higher education for the IRA owner and/or eligible family members. Are used to pay back taxes because of an Internal Revenue Service levy placed against the IRA. Except as noted in later discussions on Roth and Education IRA distributions, ordinary income taxes are still due and payable on IRA withdrawals taken under any of the above exceptions.

So how many kinds of IRAs are there, anyhow? Would you believe ... 11

Individual Retirement Account

An Individual Retirement Account is either a traditional or Roth IRA set up with a financial institution like a bank, broker, or mutual fund in which contributions may be invested in many types of securities such as stocks, bonds, money market, and CDs.

Individual Retirement Annuity

An Individual Retirement Annuity is either a traditional or Roth IRA set up with a life insurance company through the purchase of a special annuity contract.

Employer and Employee Association Trust Account, or group IRA

An Employer and Employee Association Trust Account, or group IRA, is a traditional IRA set up by employers, unions, and other employee associations for employees or members.

Simplified Employee Pension (SEP-IRA)

A Simplified Employee Pension (SEP-IRA) is a traditional IRA set up by an employer for a firm's employees. An employer may contribute up to $30,000 or 15% of an employee's compensation annually to each employee's IRA. (See our Retirement Plan Primer for a more complete discussion of SEPs).

Savings Incentive Match Plan for Employees (SIMPLE)

A Savings Incentive Match Plan for Employees IRA (SIMPLE-IRA) is a traditional IRA set up by a small employer for a firm's employees. In 2001, an employee may contribute up to $6,500 per year to these IRAs. This contribution limit will increase each year through 2005, when it will reach $10,000. In 2006 and later years, the allowable contribution will increase in $500 increments whenever the cumulative effects of inflation indicate such a rise is needed. The employer sponsoring the SIMPLE will also make a matching contribution based on a percentage of the employee's pay. In 2001, the combined employer-employee contribution to the participant's account cannot exceed $13,000. (See our Retirement Plan Primer for a more complete discussion of SIMPLEs).

Spousal

A Spousal one is either a traditional or Roth IRA funded by a married taxpayer in the name of his or her spouse who has less than $2,000 in annual compensation. The couple must file a joint tax return in the year of the contribution. The working spouse may contribute up to $2,000 per year to the Spousal IRA and up to $2,000 per year to his or her own IRA. A couple, then, may contribute up to $4,000 per year provided neither IRA receives more than $2,000.

Rollover (Conduit)

A Rollover (Conduit) is a traditional IRA set up by an individual to receive a distribution from a qualified retirement plan. Distributions transferred to a rollover IRA are not subject to any contribution limits. Additionally, the distribution may be eligible for subsequent transfer into a qualified retirement plan available through a new employer. To retain this eligibility through Dec. 31, 2001, the IRA must be composed solely of the original distribution and earnings, and the new employer's plan must allow the rollover. After Jan. 1, 2002, commingling of conduit IRA money with other IRA or qualified retirement plan money is permitted, and the mixing of such monies will have no impact on the ability to transfer those IRAs to a new employer's retirement plan.

Inherited

An Inherited IRA is either a traditional or a Roth IRA acquired by the non-spousal beneficiary of a deceased IRA owner. Special rules apply to an inherited IRA. A tax deduction is not allowed for contributions to this IRA, a rollover to or from another IRA owned by the heir is not permitted, and the proceeds must be distributed and taxed within a specific period as established by the Internal Revenue Code.

Education (EIRA)

An Education IRA (EIRA) is established to provide funds that will allow a beneficiary to attend a program of higher education. There is no tax deduction allowed for the contribution, but all deposits and earnings may be withdrawn free of tax and penalties if used to pay for the costs of higher education. Beginning in 2002, EIRA proceeds may also be used free of tax and penalty to pay for the qualified expenses of a kindergarten through 12th grade education in public, private, and/or religious schools. EIRA contributions are limited to a maximum of $500 per year, but that's in addition to the $2K limit on any other IRA. Beginning in 2002, allowable EIRA contributions increase to $2,000 per year.

Traditional

A Traditional IRA is the term for a regular IRA available to those under age 70 1/2 who have earned income (i.e., job compensation). Earnings within the traditional IRA grow tax-deferred until withdrawal. Withdrawals must begin, and will be taxed, when the owner reaches age 70 1/2. If required distributions are not taken at that age, a 50% penalty will be assessed on the amount not taken. When made, contributions may or may not be tax deductibledepending on the factors discussed previously in "All About IRAs." Aworking spouse not covered by a retirement plan through employment may make a tax-deductible contribution of up to $2,000 annually to an IRA despite the other spouse's coverage under an employer-provided retirement plan. When the couple's AGI reaches $150,000, deductibility for such contributions begins to decline, and it reaches zero at a joint AGI of $160,000.

Roth

A Roth is an IRA in which: Contributions to the account are not deductible. "Qualified" distributions (i.e., withdrawals) from the account are not taxable. Earnings on the account are taxable and subject to an early withdrawal penalty only when a withdrawal is not a "qualified" distribution.