A Quick Guide To Understanding Your Individual Retirement Account
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A Quick Guide to Understanding Your Individual Retirement Account (IRA)
Summary
It's never too early to start planning for retirement. One of the most effective ways to prepare is by setting up an Individual Retirement Account (IRA).Introduction
Preparing for retirement is a crucial step towards financial security, and an Individual Retirement Account, or IRA, is a popular tool for achieving this goal.Understanding IRAs
An IRA is a tax-advantaged personal retirement savings plan. If you're employed, whether by a company or self-employed, you can allocate a certain amount of pre-tax income into an IRA. The earnings grow tax-deferred until you withdraw them during retirement. Some individuals may also be eligible to deduct their contributions.Since 1998, Roth IRAs are an option. Contributions to a Roth IRA are not deductible, but withdrawals in retirement are tax-free.
Setting Up an IRA
Creating an IRA is relatively simple. Banks, mutual funds, brokerage firms, and other financial institutions can serve as trustees. You cannot act as your own trustee. An IRA can be set up and funded after year-end until the tax filing deadline for that year, typically April 15th.Contribution Limits
As of 2006, you can contribute up to $4,000 or your total compensation for the year, whichever is lower. Individuals aged 50 or older can make additional "catch-up" contributions of $1,000 annually.These limits apply even if you have multiple IRAs. If both you and your spouse are eligible, each can contribute the maximum, totaling $8,000, or $10,000 if both are 50 or older. In 2008, the contribution limit increased to $5,000, with the catch-up contribution remaining at $1,000.
Flexibility in Contributions
You don't need to contribute the maximum every year. You can skip years and resume contributions later, but you cannot retroactively contribute for previous years when no deposits were made.Contributions should come from earned income like wages, salaries, or commissions, but not from deferred compensations, retirement payments, or investment income like interest or dividends.
Penalties and Restrictions
Contributing more than the allowable amount incurs a 6% excise tax penalty. Contributions must be made in cash and are not permitted to inherited IRAs or once you reach age 70.5.Required Minimum Distributions
By April 1st of the year after turning 70.5, or the year you retire (whichever is later), you must start taking distributions from your IRA.A Note on Roth IRAs
Roth IRAs have different rules for contributions and withdrawals, making them a unique retirement savings option.Conclusion
This guide provides a general overview of IRAs. However, consulting with a banker, accountant, or financial advisor tailored to your individual needs can help you make informed decisions.For more detailed information, visit the [IRS website](http://www.irs.gov/taxtopics/tc451.html).
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