Your Guide to Individual Retirement Accounts

Your Guide to Individual Retirement Accounts

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Your Guide to Individual Retirement Accounts

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.

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