An IRA (Individual Retirement Account) allows saving money for retirement purposes by individuals, which entails income tax benefits. Investments in IRA are termed ‘contributions’. Contributions and earnings from them are exempt from income tax until the money is withdrawn from the account.
Withdrawals from the account are termed ‘distributions’. Distributions are taxable. The IRA Rules for distributions are more complicated than for contributions. These funds are intended for your own retirement and must be preserved. So, the premature withdrawal of IRA funds before the retirement age of 59 ½ attracts disincentives. According to IRA rules, this disincentive may amount to 10% tax penalty on the money withdrawn. It is in the light of the complexity of IRA rules that professional advice must be sought for while planning to withdraw.
Not only do the IRA rules discourage you from withdrawing money at too young an age, but they also try to prevent you from not withdrawing the money soon enough. You are expected to start withdrawing money from your IRA not later than the April 1st of the calendar year after the date you have attained the age 70 ½ . The penalty for not complying with these IRA rules might be severe.
The IRAs come in five different types:
1. Traditional IRA
One can contribute up to $2000 per year into an IRA. But according to IRA rules, the amount that qualifies for tax exemption will depend on various factors like Adjusted Gross Income (AGI), filing status (Single, Joint, etc.), coverage under employer sponsored qualified retirement plan and so on. Thus one’s contributions may range from fully deductible to completely non-deductible.
2. Education IRA
Up to $500 per year can be contributed to Education IRA for educational purposes and upon distribution to the beneficiary, it attracts preferential tax treatment. However these plans are not very common as the IRA rules that govern them are restrictive in nature.
3. SEP IRA (Simplified Employee Pension)
This is an employer established IRA. IRA rules allow up to 15% of one’s compensation to go into this account.
4. Simple IRA
This is another employer sponsored plan. IRA rules permit not only the employer but also the employee, to contribute to this account. An employee can contribute not more than $6500 per year. Separate IRA rules regarding employer contributions and premature IRA distributions apply.
5. Roth IRA
In this plan, the contributions are not deductible but the distributions are tax-free. To be eligible to contribute to this account, the AGI should be under $95,000 for singles and $150,000 for married couples. No withdrawals can be made within the first five years without inviting tax penalty, as per the existing IRA rules.
The advice of a qualified professional is to be sought to understand the IRA rules better, before one can choose the appropriate IRA plan that best fits one’s requirements.