If you are ready to start saving for retirement but your employer doesn't offer a retirement plan, an Individual Retirement Account (IRA) may be your answer. IRAs are qualified retirement plans, meaning they feature substantial tax incentives to help you prepare for the future. You can open an IRA with banks, brokerages and other financial institutions. You may have multiple IRAs as long as your yearly contributions don't exceed IRS limits.
Types
The traditional and the Roth are the two main types of IRAs. In addition there are two employer-provided IRA plans, the Simplified Employee Pension (SEP) and the Savings Incentive Match Pan for Employees (SIMPLE). SEP and SIMPLE IRAs follow the rules of traditional IRAs but differ with regard to contribution limits and eligibility criteria. Earnings in any IRA are not taxed while they remain in the account. With traditional IRAs contributions are tax-exempt. Withdrawals are subject to regular income taxes. If you open a Roth IRA you get no tax deduction. However, when earnings are withdrawn after retirement age they are not subject to income taxes.
Structure
Anyone with earned income may open an IRA. The sole exception is that you cannot open a traditional IRA after you reach age 70-1/2. You may contribute up to $5000 annually to an IRA as long as your contribution is not greater than your earned income. The limit increases to $6000 per year when you reach age 50.
Phase OUt Rules
The IRS imposes a set of "phase-out" rules that affect your ability to contribute to an IRA. If your Adjusted Gross Income (AGI) is too great, you lose the tax deduction for contributions to a traditional IRA. For Roth IRAs, you may not be able to make further contributions to the account. How much you can earn before the phase-out rules kick in depends on two things, whether you have a retirement plan at work and your tax filing status. The allowed AGI changes from year to year.
Distributions
In general you may withdraw funds from IRAs once you reach age 59-1/2. For traditional IRAs you must start mandatory distributions at age 70-1/2. For Roth IRAs there is no mandatory distribution, but your account must be at least five calendar years old before you can withdraw earnings. Since Roth contributions aren't tax-deductible, they may be withdrawn at anytime. With certain exceptions, any funds you withdraw prematurely are subject to regular income taxes and a 10 percent tax penalty
Exceptions
Funds may be distributed from an IRA and still get all the tax benefits if they are used for the purchase of a first home. For Roth IRAs there is a $10,000 limit. Qualified educational expenses like college tuition also receive the tax benefits. You may withdraw money for some other reasons without penalty although you must pay income taxes on the funds. These exceptions apply if you become disabled or use the money to pay medical expenses not covered by health insurance if the expenses exceed 7.5 percent of your income. You can use IRA funds without incurring the tax penalty to pay for health insurance while unemployed or to pay an IRS tax levy.
SIMPLE and SEP IRAs
SIMPLE IRAs allow you and your employer to contribute up to $11,500 each year as of 2010. You must have at least $5000 income the previous two years and expect the same in the current year.
SEP IRAs may be set up by a business or by someone who is self employed. To participate you must be at least 21 and have been self-employed for 3 of the last 5 years and have at least $550 in earnings in the previous year. Contributions can reach $49,000 per year as of 2010.
For both SEP and SIMPLE, employers may exclude non-resident aliens whose earnings were from outside the US and workers covered by collective bargaining agreements that include retirement
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