Series: Retirement

Page 1 of 2

The Ins & Outs of IRAs Terms of Use:

People often talk about tax breaks for the rich. Individual Retirement Accounts (or IRAs) are a tax break for the rest of us.

Congress passed IRA legislation in 1975. It is a very simple idea. Any person who doesn’t have a retirement plan at work (or just a small one) has the right to set aside money for retirement without getting taxed on it.

The legislation allows you to contribute up to a maximum amount each year and write this money off your federal and state income tax returns.

Let’s say you’re making $30,000 a year and you put $3,000 in your IRA. Now you’re only taxed on $27,000 income. However, the government does tax the money your IRA earns in interest or returns.

A common misconception is that IRAs are a kind of investment. An IRA is not a stock, mutual fund or CD – it is an account, usually held at a credit union, bank, brokerage or insurance company.

This account holds investments you select to put into it. You could think of an IRA as a “box” that you put money into and can take out only at retirement.

You can put stocks, bonds, mutual funds, CDs, share certificates, or whatever investment you want in your IRA “box”.

You can replace a bad investment for a better one, as long as you keep it in your “box”. You can choose to stop paying into your IRA. However, once you start your IRA, the government requires you to keep careful records from year to year.

If you are married, your spouse may qualify for an IRA, too. There are no joint IRAs.

You can put the maximum allowed amount in your IRA all at once on Income Tax Day (April 15th), or you can deposit little amounts throughout the year, and thereby earn even more interest and tax breaks.

A good way to keep building your IRA is to sign up for an automatic monthly deduction plan that will deposit money into a mutual fund or other investment choice before you’re able to spend it somewhere else.

If your goal is to contribute $3,000 a year, you can do so by contributing just $57.69 a week. If you contribute $3,000 each year to a Roth IRA growing tax-free at the historical average of 10.6% for the stock market, you will have more than $500,000 in 30 years.

Series: Retirement

Page 2 of 2

The Ins & Outs of IRAs Terms of Use:

If you start in your twenties and put $3,000 into this same Roth IRA each year, you will have $5.2 million by age 70! Let’s say you make only 8% annual return, you’ll still wind up with $1.9 million!

One disadvantage of an IRA is that your money must stay in your IRA until you reach age 59½ or else you have to pay a big penalty. Currently, it’s 10% of the money plus all back taxes. There are exceptions such as needing the money for medical expenses, disability or higher education.

With a Traditional IRA, contributions (or deposits) may be deductible, depending on your income and whether you participate in an employer-sponsored retirement plan. Earnings grow tax-deferred and taxes are not paid until distributions (or withdrawals)

Contributions to a Roth IRA are not tax deductible, but distributions from the account are not taxable, so your investments in this type of account grow tax-free.

With a Traditional IRA, you must start taking money out by age 70. With a Roth IRA, you don’t have to start taking money out at age 70; in fact, you can keep putting money into it.

Once you start spending your Traditional IRA money, the government taxes it like income.

But, since your withdrawal occurs during retirement, your income is probably less so you will be taxed at a lower rate.

With a Roth IRA, there are no taxes on your IRA returns and no taxes when you take out the money, as long as you leave it alone for at least five years.

It’s possible for you to keep more of your money away from the IRS with an IRA. And you can decide whether to save on taxes now with a Traditional IRA or save on taxes when you retire with a Roth IRA.

The Coverdell Education Savings Account, previously known as an Education IRA, is another type of IRA that is available to those wanting to save specifically for college.

For frequently asked questions about IRAs, click here. For more information on Coverdell Education Savings Accounts and other education tax breaks, click here.

There are many rules about IRAs, and these rules change almost yearly. For a complete list of rules and to figure out which kind of IRA you qualify for, get Publication 590 from the Internal Revenue Service or click here.

IRAs - perhaps if we called them “Tax Loophole Accounts,” more people would open them.

See what you learned.