An individual
retirement account, commonly known as an IRA or traditional IRA, is a
retirement plan that allows the account holder to make pre-tax contributions to
save for future use. Individual retirement accounts are created through a
financial institution such as a bank or a brokerage firm which allow the
account holder to deposit funds from wages earned before taxes. The money
deposited can accrue interest if place in certificates of deposit from banks or
in mutual funds through a brokerage firm.

Individual retirement accounts were first made available in
1975, but were officially noted under the Tax Reform Act of 1986 (TRA) as a
part of the Internal Revenue Code. As such, the Internal Revenue Services (IRS)
defines an IRA as a qualified retirement plan.

Traditional individual
retirement accounts also allow the account holder to receive certain tax
deductions only if they qualify under guidelines set by the IRS. These
guidelines include having income, tax filing status, and being able to invest
in other qualified retirement plans. The funds placed in an individual
retirement account are not taxable under federal income taxes as the funds are
deposited on a pre-tax basis. This means that contributions are made before the
account holder receives wages and uses them, thus deducting them from the
account holder’s annual income. 

The IRS also places additional restrictions on individual
retirement accounts in regard to withdrawals, also known as distributions, and
contributions. The IRS penalizes any withdrawals made from an individual
retirement account prior to the age of 59.5 by taxing those monies under
federal income taxes just as with a 401(k) plan. This is because those funds
are being used for purposes other than retirement and have been returned to the
account holder’s annual income.

Additionally, funds in an individual retirement
account must be distributed prior to the account holder reaching the age of
70.5. This allows the account holder to continue to accrue interest for a
period of time after reaching full retirement age. The IRS also places annual
restrictions how much money can be contributed to an IRA. This means that the
account holder can make contributions up to the maximum amount as set by the
IRS. If the contributions exceed that amount, the excess must be withdrawn
prior to April 15th of the next tax year.

Loans are not permitted to be taken from an individual
retirement account. The IRS has the power to disqualify the account and then
tax the account holder on the contributions contained in said account. If the
account holder needs money from the IRA, he or she must make a distribution
which is then taxed and noted by the IRS.

The nature of traditional individual
retirement accounts, as pre-tax deferred compensation retirement plans, does not
allow the account holder to place post-tax monies into the account. This is
done to ensure that the account holder is properly saving for retirement and
not using the account as a checking account, for example.

 The
Internal Revenue Service (IRS) sets forth special regulations and provisions in
regard to the operation and funding of an individual retirement account (IRA)
by making an IRA contribution. These provisions are found the Tax Reform Act of
1986 and in the Internal Revenue Code. These legislations govern how the IRS
operates and taxes citizens of the United States.

Additional legislation that
affects making an IRA contribution is the Employee Retirement Income Security
Act of 1974 and the Economic Growth and Tax Relief Reconciliation Act of 2001.
These acts have been passed by Congress to amend and modify the Internal
Revenue Code.

One provision that affects an individual retirement account
are the taxes imposed by the IRS. Federal income taxes do not affect IRA
contributions except in the case of a withdrawal. Funds are deposited in an IRA
on a pre-tax basis. This means that they are not subject to income taxes since
they are deducted from the account holder’s income prior to receiving wages.

An
IRA contribution can be made on either a biweekly or monthly basis to fund the
IRA. However, if an account holder should decide to withdraw funds, or make a
distribution, those funds are then subject to federal income taxes. Another tax
that affects IRA contributions is what is known as an excise tax. This tax is
imposed by the IRS as a penalty for the withdrawal of funds. An excise tax is
equal to 10 percent of the amount of the distribution. If $1,000 is withdrawn,
the excise tax is equal to $100 and collected by the IRS.

Another provision that affects IRA contributions is the age
at which funds are intended to be withdrawn. As set by the IRS, the age where
IRA contributions can be withdrawn without being subject to penalties is 59.5.
This places the account holder close to full retirement age and therefore able
to retire. Full retirement age is mandated by the Social Security
Administration (SSA) and is different for each person depending on the year in
which they were born.

For example, if the account holder was born in 1960 or
later, the full retirement age is then 67 as set by the SSA. The IRS also
mandates that IRA contributions must be distributed by the time the account
holder reaches the age of 70.5 This age places the account holder beyond full
retirement age and allows IRA contributions to continue to accrue interest for
retirement purposes. However, the IRA must be completely distributed at this
point.

The IRS also sets limits the amount of IRA contributions
that can be deposited in an IRA in a given year. This limit often changes
annually in $500 increments but is ultimately declared by the IRS each year. If
an account holder should make an IRA contribution that exceeds this set
limitation, those funds must be withdrawn prior to April 15th – this is the day
that tax returns must be filed by. The excess amount of the IRA contribution is
also subject to federal income taxes and the excise tax penalty.

A Savings
Incentive Match Plan for Employees (SIMPLE) IRA is an retirement plan that can
be offered through an employer to encourage employees to save for retirement.
As it is a deferred compensation plan, the money is intended to be withdrawn
when the employee reaches retirement age or the age of 59.5 as mandated by the
Internal Revenue Code.

In a SIMPLE IRA, the employer is required to match a
percentage of the contributions made to the IRA by the employee. This is done
through either “elective-deferral” contributions or
“non-elective” contributions.

Elective-deferral
contributions: These are contributions where an employer matches the
contributions based on the amount contributed by an employee from that
employee’s salary. 

Non-elective
contributions: These are contributions made by the employer to an employee’s
IRA but are not based on the contributions made by the employee.

The Internal Revenue Code has established provisions for the
creation of SIMPLE IRAs on the behalf of employers. In order to offer a SIMPLE
IRA to employees, the employer must have less than 100 persons in its employ
each year in order to be eligible for this type of IRA. Those employees must
also have earned a minimum of $5,000 in any two years prior to the creation of
the SIMPLE IRA.

If an employer should exceed the 100 person limit, that
employer may continue to offer SIMPLE IRAs for up to two years after the limit
has been exceeded. However, after that two year period expires and if the
employer continues to exceed the 100 person limit, the employer loses
eligibility to offer the SIMPLE IRA retirement option. 

Additional provisions that determine if an employer may
offer a SIMPLE IRA are deadlines and other options offered. A SIMPLE IRA must
be established between January 1st and October 1st of the year in which
contributions are to be made. However, if an business is established after
October 1st, the employer is still eligible to provide the SIMPLE IRA plan as
soon as it is feasible. An employer will also be considered ineligible to
provide SIMPLE IRAs if that employer offers any of the following options:

401(k)
plans;

403(b)
plans;

Qualified
annuity plans;

Employee
funded pensions;

SEP
IRAs;

or,
A benefits plan provided by state or federal agencies.

An employer must make contributions to the SIMPLE IRA each
year that the IRA is funded. The employer has until April 15th to make those
contributions as that is the date that tax returns must be filed. If the
employer makes an elective-deferral contribution, the employer can match an
employee’s contributions dollar-for-dollar up to 3 percent of the wages earned
by the employee that year.

If the employer makes a non-elective contribution,
the employer can make a contributon up to 2 percent of that employee’s
compensation earned that year. If the employer makes a dollar-for-dollar
contribution but the contribution made by the employee is less than 3 percent
of their annual wages that year, then the employee can only match the amount
contributed by that employee.

Any withdrawals made from SIMPLE IRAs prior to the employee
reaching the age of 59.5 is subject to a penalty of 10 percent of the withdrawn
amount. Also, if the funds in a SIMPLE IRA have been withdrawn or transferred
within the two years following the creation of the IRA, the employee is subject
to a 25 percent penalty (not the 10 percent penalty) on the amount moved; this
is because SIMPLE IRAs are not to be moved during the two years after its
creation as mandated by the “Two Year Rule”.

These penalties, known
as excise taxes, are made in addition to any income taxes that would apply to
the funds withdrawn.

Individual
retirement accounts, or IRAs, are retirement plans that allow people to save
money for the future after retiring from the workforce. These plans, depending
on the type, allow money to be deposited by either the account holder or their
employer each year up until the account holder decides to retire. 

The Employee
Retirement Income Security Act of 1974 (ERISA) allowed for the creation of the
IRA by amending the Internal Revenue Code. Under ERISA, an employee could
initially set aside up to $1,500 each year towards retirement. But as new
legislation came about, that allowed for more money to be placed in an IRA.

The types of individual retirement accounts that can be
created are IRAs (traditional IRAs), Roth IRAs, SEP IRAs, and SIMPLE IRAs. These
plans operate in a slightly different manner from each other but follow the
same principle in that they are intended to help the account holder effectively
plan for their retirement.

Basic Information

Individual retirement accounts, or
traditional IRAs, were first available to citizens of the United States in
1975. They were intended to be used for workers in a higher tax bracket in
order to help them save for retirement. As they are now, almost anyone can
establish an IRA through an employer that offers it or directly through a
financial institution.

A financial institution, such as a bank or brokerage
firm, is involved with the IRA through either method. This allows for funds to
be invested in a certificate of deposit or in a mutual fund while still growing
through the contributions of the the account holder.

As IRAs are intended for the retirement of the account
holder, loans and withdrawals made before retirement are penalized by the
Internal Revenue Service. The related penalties and taxes that affect an IRA
are listed in the Internal Revenue Code. However, the funds placed in a
traditional IRA are not taxable by income taxes as they are deposited on a
pre-tax basis.

Provisions

The Internal Revenue Code, as administered by
the Internal Revenue Service (IRS), outlines provisions, restrictions,
limitations and penalties to be applied to IRAs. These provisions often apply
to the contributions made to the IRA, withdrawals from the IRA, and the taxes
that can affect the IRA

These provisions have been made through legislation
that amended the Internal Revenue Code such as the Employee Retirement Income
Security Act of 1974 (ERISA), the Tax Reform Act of 1986 (TRA), the Economic
Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the and the Pension
Protect Act of 2006 (PPA).

The most common provisions set by the IRS in regard to IRAs
are based on age, contributions made to the retirement account, withdrawals
from the retirement account, and any penalties or taxes under the Internal
Revenue Code.

Roth IRAs

A Roth IRA, named after the late Senator
William Roth, is modified form of an IRA. This retirement plan allows the
account holder to place funds in the fund just as with a traditional IRA.
However, the contributions made to a Roth IRA are not tax deductible as with a
traditional IRA. Conversely, distributions, or withdrawals, made from a Roth
IRA are generally free from additional taxes or penalties. This is because the
funds in a Roth IRA are still listed under the income of the account holder.

One major requirement of having a Roth IRA is
that it must “season” for a minimum of 5 years. “Seasoning”
means that the account has been allowed to grow and mature through
contributions and investments made to the retirement plan.

After this period,
the IRA can then be distributed or transferred depending on the wishes of the
account holder. Roth IRAs also allow the account holder to transfer the funds
to a specific beneficiary under certain circumstances or purchase a home with a
portion of the contributions of the IRA.

A Roth 401(k) plan, made available in 2006, combines the
benefits of a Roth IRA and a 401(k) plan.

SEP IRAs

An SEP IRA, or Simplified Employee Pension
IRA, is a retirement fund that is created through a traditional IRA and facilitated
by an employer. The employer can only offer this type of retirement plan so
long as it does not offer any other retirement plans.

Employers can also make
contributions to the SEP IRAs of its employees. Although this helps the growth
of the retirement account, there are restrictions to the amount of
contributions an employer can make.

As an SEP IRA is created through a traditional IRA, the only
difference between the accounts are certain restrictions and the label placed
on the IRA. There are also additional eligibility requirements placed on the
account holder based on age, income and length of employment with that
particular employer.

SIMPLE IRAs

A SIMPLE IRA, or Savings Incentive Match Plan
for Employees IRA, is a retirement fund that is also facilitated through an
employer. However, with this plan, the employer is required to make
contributions annually to the retirement plan even if an employee does not.
This provides an incentive for the employee to contribute to his or her
retirement and save money for the future. 

These IRAs have additional restrictions placed on both the
employer and the employee. The employer can only offer this type of retirement
fund in a benefits package given to all employees, there is a limit to how many
employees the employer can have to offer this IRA, and the IRA must be
established between certain dates. In regard to the employee, there are
additional penalties applied to withdrawals from the account as it has been
created strictly for retirement purposes.