An individual retirement account (IRA) is a personal savings plan that offers income-tax benefits to individuals who set money aside for retirement. Anyone can open and contribute to a traditional IRA as long as you received taxable earned compensation (wages, salaries and fees received for personal services, including net self-employment income during the year) and have not yet turned 70 1/2 by the end of the year. According to New York Life, you can open an IRA at nearly all banks, brokerage firms or insurance companies. There are a wide variety of investment options to select from.
Contributions
Your investments into an IRA are called contributions. An annual cap can be placed on your contribution amount under the federal tax law. In many cases there is an income-tax deduction offered for the tax year in which the funds are deposited into the IRA. The money you put into an IRA, along with its earnings and gains, grow tax-free until you are ready to take out the money.
Distributions
Withdrawing money from your IRA is termed a distribution. These withdrawals are subject to income tax. If you opt for a distribution before you turn 59 1/2, there is generally a 10-percent tax penalty as well. However, you are also discouraged from holding on to your IRA funds for too long. You normally must begin withdrawing your money no later than April 1 of the calendar year following the date you turn 70 1/2.
Traditional IRA
Under the rules of a traditional IRA, you may contribute up $5,000 annually into the account as of 2009. People older than 50 can contribute an extra $6,000. The amount you are permitted to deduct on your federal income tax return will vary based on your adjusted gross income. The deductible amount will also depend on your filing status.
Roth IRA
The contributions made to a Roth IRA are not tax-deductible, but your deposits are tax exempt and remain that way when they are withdrawn; you only pay taxes on earnings. Too qualify for a Roth IRA as of 2010, a single person must earn less than $110,000 and married couples can ear no more than $160,000. Once the account is opened, the funds must remain untouched for a period of five years. Unlike traditional IRAs, a mandatory distribution at age 70 1/2 is not requirement for Roth IRAs. You can contribute to them for as long as you have earned income.
Education IRA
A maximum of $500 per year can be deposited into an education IRA, and the money accumulates tax free. Education IRAs are not particularly common, because there are strict rules regarding who can make contributions and there are limitations on the precise definition of education expenses.
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