What Is an IRA?

1 What Is an IRA?

An IRA (Individual Retirement Account) provides tax breaks for individuals who wish to set aside money for retirement. For a traditional IRA (discussed here), contributions are tax deductible when originally made, but contributions and earnings are taxed when withdrawn. 

2 Who Is Eligible to Contribute to an IRA?

If you have earned income, and are under the age of 70-1/2, you are eligible to contribute to a traditional IRA. 

3 How Much Can I Contribute to an IRA Per Year?

Annual contribution limits are defined by the tax code. Contribution limits may change each year. If contributors are 50 years of age or older, they may be allowed a catch-up provision of an additional amount of money per year. Maxing out an IRA on an annual basis can greatly increase the size of your retirement portfolio over time, and the government has continually raised annual contribution limits to encourage people to save for retirement. To make an annual contribution, you have the entire year, as well as until April 15 of the following year, to contribute. For example, if you contribute $5,000 to your IRA for a calendar year, you would have all of that year, as well as January 1 through April 15 of the following year, to apply the contribution. 

4 When Can I Begin Withdrawing My IRA Funds?

Generally, you may begin withdrawals from your traditional IRA at age 59-1/2. You must begin minimum required distributions (withdrawals) from your traditional IRA at age 70-1/2.

5 Are There Penalties for Early Withdrawal of IRA Funds?

In many cases, you will pay a 10 percent early distribution penalty on a withdrawal from a traditional IRA, if you withdraw before age 59-1/2. You may also pay taxes, since traditional IRA contributions are originally tax deductible. The 10 percent penalty may be overridden in certain cases, such as:

• The purchase of a first home
• Higher education expenses
• Expenses related to disabilities suffered
• Expenses related to medical issues

It may be best to consult a tax advisor to see whether you qualify for an exemption from the penalty in certain cases.In some cases, you may have a 60-day grace period to return your early withdrawal back to your traditional IRA, without penalties or taxes applied. Such a withdrawal can only be done once every 365 days.

6 Can I Convert My IRA to a Roth IRA?

You may qualify to rollover your traditional IRA to a Roth IRA, within a 60-day period. Eligibility depends upon your Adjusted Gross Income (AGI). When you convert from a traditional to a Roth IRA, you’ll pay taxes up front since the traditional IRA is a pretax contribution and the Roth IRA contributions are made after taxes. Your unique tax situation will determine whether conversion from a traditional to a Roth IRA is the best choice for you. If you change your mind within the 60-day rollover period, you may return your money to the traditional IRA.

7 What Is the Difference between a Roth IRA and a Traditional IRA?

Traditional IRA contributions are tax deductible; Roth contributions are not. However, Roth IRA earnings are tax free. In many cases, the Roth IRA offers more flexibility for contributing and withdrawing funds. Your unique financial and tax situation will determine whether a Roth or traditional IRA is most beneficial for you. 

8 Can I Contribute to a Traditional IRA if I Am Contributing to Another Retirement Plan?

Yes, you can contribute to the traditional IRA when contributing to another plan. Depending on the amount of your Adjusted Gross Income (AGI), you may not be able to deduct the entire amount of your contribution. See Publication 590, About IRAs, at the IRS Web site www.irs.gov. 

9 If My Spouse Is Not Working, Is She or He Eligible to Make an Annual Contribution to a Traditional IRA?

Yes, your spouse may make the full annual contribution to a traditional IRA for the year, if you had earned income in that year.

10 Where Can I Learn More about IRAs?

Here are a few of many resources that cover the traditional IRA:

· Retirement Plans and FAQs regarding IRAs: http://www.irs.gov/retirement/article/0,,id=111413,00.html
· Individual Retirement Arrangements: http://www.irs.gov/pub/irs-pdf/p590.pdf
· IRS Information about Traditional IRAs: http://www.irs.gov/retirement/article/0,,id=137283,00.html