Individual retirement account

In 1974 the Employee Retirement Security Act created the Individual Retirement Account (IRA), allowing eligible persons to establish their own tax-deferred retirement savings plans from which withdrawals can be made after age 70½. These so-called “traditional IRAs” offer an immediate tax benefit by deducting the allowed amount saved from the annual taxable INCOME, though there are some exceptions. When funds—principal and interest— are withdrawn, they are taxed. Early withdrawals, unless exempt, are subject to an additional 10-percent excise tax. The Roth IRA, established in 1998 and named for Delaware senator William Roth, does not offer investors an immediate tax write-off but allows them to make taxfree withdrawals after the mandatory age of 59½. In June 2001 President George W. Bush signed the Economic Growth and Tax Relief Reconciliation Act (EGTRRA), which changed tax and labor laws, including an increase in the maximum dollar amount of contributions to traditional and Roth IRAs. Contributions can be made only from earned income, wages, salaries, and tips. Married couples who file joint income-tax returns are excepted; even if one does not work, each may make a contribution for their “combined” income, with some limitations (see below). Until the passage of EGTRRA, the maximum annual contribution had been $2,000 per individual; the amount increased to $3,000 for 2002–04, to $4,000 for 2005–07, and to $5,000 for 2008 and beyond. For 2002–03, individuals 50 and older may take an additional $500, for a total of $3,500. A married couple’s contributions to the traditional IRA may not be tax-deductible, depending on their enrollment in a qualified RETIREMENT PLAN and their adjusted gross income (AGI) level. A nonworking spouse’s tax deduction is phased out if the working spouse is in a retirement plan and their joint AGI falls between $150,000 and $160,000 (filing jointly); the phase-out begins limiting the deduction starting at $150,000 and increases so that there is no deduction at $160,000 or more. Similarly, if the working spouse is in a retirement plan, his or her deduction is decreased once the AGI reaches $54,000, with total phaseout at $64,000. If neither is in a retirement plan, deductions are allowed, regardless of AGI. If both work and are in retirement plans, deductions again are phased out from $54,000 to $64,000. The range is $95,000–$110,000 for single filers. Future traditional IRA phase-out ranges for married couples filing jointly with a working spouse in a retirement plan are 2003:

2003: $60,000–$70,000 ($40,000–$50,000 single filer);
2004: $65,000–$75,000 ($45,000–$55,000 single filer);
2005: $70,000–$80,000 ($50,000–$60,000 single filer);
2006: $75,000–$85,000 ($50,000–$60,000 single filer);
2007: $80,000–$100,000 ($50,000–$60,000 single filer).

Though tax deductions are not an option with Roth IRAs, a taxpayer’s AGI can limit eligibility. Eligibility to contribute to a Roth is phased out between $150,000 and $160,000 for married couples filing jointly, between $95,000 and $110,000 for single filers, and between $0 and $10,000 for married couples filing individually. Roth IRA investors can be penalized both for making early withdrawals and for failing to make withdrawals after age 70½. “Unauthorized” withdrawals made before age 59½ incur a 10-percent tax, and failure to make minimum withdrawals after 70½ are penalized 50 percent on the amount not taken. There are exceptions to the 10-percent early-withdrawal tax, although these are still subject to regular income tax. The exempted withdrawals are those made
• because of the disability or death of the IRA holder
• that represent a series of “substantially equal periodic payments” made over the life expectancy of the owner
• that are used to pay medical expenses not reimbursed and exceeding 7½ percent of the AGI
• that are used to pay medical INSURANCE premiums after the owner has received UNEMPLOYMENT compensation for more than 12 weeks
• that are used to pay the costs of a first-time home purchase (lifetime limit of $10,000)
• that are used to pay for the qualified expenses of higher education for the IRA owner and/or eligible family members
• that are used to pay back taxes from an IRS levy against an IRA Types of IRAs include the following.
1. A traditional or Roth Individual Retirement Account is set up through a bank, broker, or mutual fund. INVESTMENTs may be made in stocks, BONDS, money markets, and certificates of deposit (CDs).
2. An Individual Retirement Annuity is the same as a traditional or Roth IRA, except that a life insurance company sets up the account through an ANNUITY contract.
3. A group IRA, or Employer and Employee Association Trust Account, works like a traditional IRA but is run through an employer, UNION, or other employee association.
4. A Simplified Employee Pension (SEP-IRA) is a traditional IRA set up by a business for its employees. The employer may contribute up to $30,000, or 15 percent, of an employee’s compensation annually to his/her IRA.
5. A Savings Incentive Match Plan for Employees IRA (SIMPLE-IRA) is a traditional IRA set up by a small employer for its employees. The contribution limit will increase each year through 2005, when it will stop at $10,000. The limit will increase by $500 a year from 2006 on. Employers may also match a percentage of their workers’ contributions, with the combined amount not to exceed a set limit each year.
6. A Spousal IRA is either a traditional or Roth IRA funded by a married taxpayer in the name of his or her nonworking spouse. The couple must file a joint tax return in the year of the contribution. The limits established under EGTRRA hold true for the nonworking spouse.
7. A Rollover (Conduit) IRA is a traditional IRA that receives a distribution from a qualified retirement plan. Distributions are not subject to any contribution limits and may be eligible for transfer into a new employer’s qualified retirement plan.
8. An Inherited IRA is either a traditional or a Roth IRA acquired by the nonspousal beneficiary of a deceased IRA owner. A tax deduction is not allowed for contributions to this IRA.
9. An Education IRA (EIRA) is established to allow a beneficiary to attend an institute of higher education. Contributions aren’t tax-deductible, but withdrawals to pay the costs of higher education are not taxed or penalized. Beginning in 2002, EIRA funds also can be used to pay for education for kindergarten through 12th grade, with a maximum contribution of $2,000 (in addition to any other IRA contributions).
See also SIMPLIFIED EMPLOYEE PENSION.