Guest Author - Reshma Vyas
The subject of IRAs inevitably turns up in any conversation on retirement planning. Although the IRA has been around for more than 3 decades (it was originally established in 1974 under the guidelines of “The Employee Retirement Income Security Act” or ERISA), it can still be a complicated and confusing investment for many individuals. There are so many types of IRAs (approximately 11, at last count!) and each type of IRA comes with its own intricate set of rules and guidelines that can be rather cumbersome to sort out for the average investor. Even selecting the “right” IRA can present as a difficult and time-consuming endeavor; traditional IRA or Roth IRA? SEP-IRA or Simple IRA? Or, how about the self-directed IRA?
Let’s take a look at one of the most popular retirement vehicles for tax-deferred growth for most Americans: the Independent Retirement Account known simply as the IRA or “traditional” IRA.
Who qualifies for an IRA?
Anyone who earns income (taxable earned compensation) during the calendar year and is not 70 ½ . “Compensation” is defined to include salaries, bonuses, tips, commissions, fees and even taxable alimony.
How much can I contribute to an IRA?
Generally speaking, for the tax year 2008, the contribution limit is $5000. Individuals aged 50 (to qualify, you must turn 50 during the year in which you are making the contribution) and over, the contribution limit is $6000. For 2010 and after, the amount will be inflation-adjusted. It is essential to note that there are strict contribution limits based upon a wide range of circumstances. For example, individuals who participated in their company’s
401(k) plan and the company went into bankruptcy may be eligible (if they meet the specific conditions) to make “catch up” contributions to an IRA.
Are there any fees associated with an IRA?
As an IRA is a custodial account the trustee may charge a managerial and/or administration fee. Typically, most individuals have an IRA established with a mutual fund company and the fees mutual fund companies charge can vary greatly. The fee is usually in the range of $10-$50, or higher in some cases.
Where can I invest my IRA?
One can invest the money for an IRA account in certificates of deposit, money market funds, mutual funds, bonds, even real estate. However, life insurance and collectibles are ineligible for investment. For a complete list of non-eligible investments, one can refer to Publication 590 at IRS.Gov.
Is my IRA tax-deductible?
How much of your IRA is tax-deductible depends on your tax bracket in addition to other factors. Generally, if you and your spouse do not participate in any other qualified retirement plan such as a 401(k), your contributions are tax-deductible. However, if you and your spouse do participate in a qualified retirement plan and also contribute to an IRA, the amount you can deduct will be based on your Modified Adjusted Gross Income (AGI) and your filing status.
When can I withdraw my money?
You are eligible for withdrawal after 59 ½. However, once you reach 70 ½ , you must, as required by law, begin taking out required minimum distributions, often referred to as “RMD.” Distributions must be withdrawn starting April 1 of the year in which the participant reaches age 70 ½ . If the participant fails to make the minimum required distributions, there will be a 50% tax on the amount of money that is not distributed. The distribution amount will vary from year to year. It is calculated in part based on life expectancy charts. Special note: a waiver for RMD which is in effect for only tax year 2009 exempts some retirees from taking distributions from their IRA.
Are there any penalties associated with early withdrawal?
Yes, if you withdraw the money before age 59 ½ , there will be a 10% tax penalty on the amount withdrawn in addition to ordinary income tax. However, there are exceptions to this rule and individuals can make an “early withdrawal” from an IRA under specific circumstances:
1. Withdrawal of funds from an IRA before age 59 ½ is permitted if the owner of the IRA becomes disabled.
2. If the owner of an IRA dies, the beneficiary(s) are permitted to withdraw funds from the IRA.
3. An individual can withdraw a maximum of $10,000 in order to purchase their first home. However, the amount must be used within 120 days to pay for the costs of the home.
4. If the money is used towards the reimbursement of medical expenses that exceed 7 ½ % of your Modified Adjusted Gross Income (AGI).
5. The money is used for higher education costs.
Note however, that “early withdrawls” from the traditional IRA do not exempt individuals from taxes.
How does divorce affect my IRA?
An IRA can be transferred tax-free to a spouse in the event of a divorce through two methods; changing the name of the owner of the IRA or direct transfer. The direct transfer method is frequently utilized. It merely involves providing instructions to the trustee of the IRA to transfer the assets to the trustee of the new or existing IRA established in the name of the new owner.
Special note: IRA rules regarding investments, eligibility, contributions, distributions and deductions are highly complex and it is prudent to consult with a knowledgeable tax professional.