individual retirement account

An IRA is a retirement investing tool that can be either an "individual retirement account" or an "individual retirement annuity". There are several types of IRAs: Traditional IRAs, Roth IRAs, SIMPLE IRAs and SEP IRAs.

Traditional and Roth IRAs are established by individual taxpayers, who are allowed to contribute 100% of compensation (self-employment income for sole proprietors and partners) up to a set maximum dollar amount. Contributions to the Traditional IRA may be tax-deductible depending on the taxpayer's income, tax-filing status, and coverage by an employer-sponsored retirement plan. Roth IRA contributions are not tax-deductible.

SEPs and SIMPLEs are retirement plans established by employers. Individual participant's contributions are made to SEP IRAs and SIMPLE IRAs.

Also referred to as "Individual Retirement Arrangements."

Investopedia Says:
Eventual withdrawal is taxed as income, including the capital gains, but since your income is likely to be less once you retire, you will be taxed at a lower rate. Combined with potential tax savings at the time of contribution, IRAs can prove to be very valuable tax management tools for individuals. Also, depending upon an individual's income, they may be able to fit themselves into a lower tax bracket with tax-deductible contributions during their working years while still enjoying a low tax bracket during retirement.

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We offer up a checklist of some of the requirements needed to make these payments in a timely manner. IRA Contributions: Eligibility & Deadlines
Find out where you can take a tax deduction on the contributions you make. Traditional IRA Deductibility Limits
If you need to take early distributions, learn under which circumstances you won't suffer expensive consequences. Taking Penalty-Free Withdrawals From Your IRA
Find out what requirements must be met and how it is done. Deducting Losses on Your IRA Investments
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Tax-deferred retirement account allowing an individual to contribute a pre-set amount annually (up to $4,000 in 2006, or $8,000 for a married couple filing jointly) from personal income. The maximum individual contribution will rise to $5,000 in 2008 and afterward will be indexed according to inflation. Individual taxpayers over age 50 are permitted an additional $1,000 a year "catch up" IRA contribution. IRA contributions are tax deductible regardless of income if neither the taxpayer nor their spouse is enrolled in an employer-sponsored pension plan. Individuals covered by a company retirement plan may deduct IRA contributions if adjusted gross income is below $53,000 on a joint return or $33,000 on a single return. Couples with incomes between $53,000 and $63,000 and single taxpayers with incomes between $33,000 and $43,000 are allowed partial deductions. After 2007, the income limit for fully deductible IRA accounts will rise to $50,000 for single taxpayers and $80,000 for married couples. Individuals barred from making deductible contributions may open nondeductible IRA accounts and gain the benefit of tax deferral on earnings.

Withdrawals from an IRA before age 591⁄2 are generally subject to a 10% penalty tax, although certain types of withdrawals are exempted. Individuals may contribute annually to an IRA account until age 701⁄2. After reaching that age, individuals must begin withdrawing funds according to an IRS schedule based on life expectancy. IRA accounts may be invested in many different types of investments, including stocks, bonds, certificates of deposit, and mutual funds.

See also 401(K) Plan; Individual Retirement Account Rollover; Keogh Plan; Roth Ira; Self-Directed Ira.

An individual retirement account (IRA) is a tax-deferred retirement program in which any employed person can participate, including self-employed persons and small business owners. In most cases, the money placed in an IRA is deducted from the worker's income before taxes and is allowed to grow tax-deferred until the worker retires. IRA funds can be invested in a variety of ways, including stocks and bonds, money market accounts, treasury bills, mutual funds, and certificates of deposit. Intended to make it easier for individuals to save money for their own retirement, IRAs are nonetheless subject to a number of complex government regulations and restrictions. The extent of annual contributions, and the tax deductibility thereof, are dependent on the individual worker's situation.

The main difference between IRAs and employer-sponsored retirement plans is that IRA funds—although held by a trust or annuity—are under the complete discretion of the account holder as far as withdrawals and choice of investments. For this reason, IRAs are known as self-sponsored and self-directed retirement accounts. Even combination plans that allow employers to make contributions, like Simplified Employee Pension (SEP) IRAs, are considered self-sponsored since they require the employee to set up his or her own IRA account. A special provision of IRAs allows individuals to roll over funds from an employer-sponsored retirement plan to an IRA without penalty.

IRAs were authorized by Congress in 1974 as part of a broader effort to reform laws governing pensions. Recognizing that employers facing intense competition might decide to cut costs by reducing the retirement benefits provided to employees—and that government programs such as Social Security would not be enough to fill in the gaps—Congress sought to encourage individual taxpayers to undertake long-term savings programs for their own retirement. The Internal Revenue Service responded by making provisions for individual retirement accounts in section 408 of the tax code. IRAs quickly became recognized as one of the most opportunistic and flexible retirement options available, enabling workers to control their own preparations for the conclusion of their working lives.

Ira Provisions

In the original provisions, elective pre-tax contributions to IRAs were limited to $1,500 per year. The maximum annual contribution increased to $2,000 in 1982, but new restrictions were imposed upon workers who were covered under an employer's retirement plan. For example, such workers were not eligible to deduct their total IRA contributions unless their adjusted gross income was less than $25,000 if unmarried, or less than $40,000 if married. A partial deduction was available for single workers who earned up to $35,000 and married workers who earned up to $50,000, but no deductions were allowed for people with higher income levels. These restrictions did not apply to self-employed individuals and others who did not participate in an employer's plan. In 1998, the income limits for people covered under an employer's retirement plan were increased to $30,000 for unmarried workers and $50,000 for couples.

The way the tax code was written, individuals were intended to begin making regular withdrawals from their IRAs upon retirement. These withdrawals would be considered income and subjected to income tax, but the individual was presumed to be in a lower tax bracket by this time than they had been during their working years. "Ordinary" distributions from an IRA are those taken when a worker is between the ages of 59½ and 70½. Though workers are not required to begin receiving distributions until they reach age 70½, most establish a regular schedule of distributions to supplement their income during this time. The total annual distributions cannot exceed $150,000 per year, or they are subject to a 15 percent penalty in addition to the regular income tax. "Early" withdrawals, or those taken before a worker reaches age 59½, are subject to a 10 percent penalty on top of the regular income tax, except in cases of death or disability of the account holder. This penalty is intended to discourage younger people from viewing an IRA as a tax-deferred savings account. "Late" withdrawals, or those beginning after a worker reaches age 70½, are subject to a whopping 50 percent penalty. Since IRAs are supposed to provide income for the worker during retirement rather than inheritance for others after the worker's death, the government imposed an especially stiff penalty to ensure timely distributions.

Subsequent legislation—in particular, the Tax Reform Act of 1986—has refined the scope, provisions, and requirements of IRAs so that other forms are available besides the basic, individual "contributory" IRA. As outlined by W. Kent Moore in The Guide to Tax-Saving Investing, the different IRA variations include: 1) spousal IRAs, which enable a working spouse to contribute to an IRA opened for a nonworking partner; 2) third-party-sponsored IRAs, which are used by employee organizations, labor unions, and others wishing to contribute on workers' behalf; 3) Simplified Employee Pensions (SEPs), which enable employers to provide retirement benefits by contributing to workers' IRAs; 4) Savings Incentive Match Plan for Employees (SIMPLE) IRAs, which require employers to match up to 3 percent of an employee's salary, or $6,000 annually, plus allow employees to contribute another $6,000 per year to their own accounts; 5) rollover contribution accounts, which allow distributions from an IRA or an employer's qualified retirement plan to be reinvested in another IRA without penalty; and 6) Roth IRAs, which enable single people with an annual income of less than $95,000 and married couples with an annual income of less than $150,000 to make a nondeductible contribution of $2,000 per year, whether they are covered by an employer's plan or not. It is also possible for those earning less than $100,000 per year to convert a regular IRA to a Roth IRA by paying any deferred income tax. Though money placed in Roth IRAs is subject to taxes when invested, the earnings grow tax-deferred and the withdrawals are tax-free after five years.

Factors to Consider

Those interested in opening an IRA should familiarize themselves with the current regulations governing the amounts that may be contributed, the timing of contributions, the criteria for tax deductibility, and the penalties for making early withdrawals. They should also shop around when investigating financial institutions that offer IRAs—such as banks, credit unions, mutual funds, brokerage firms, and insurance companies—inasmuch as fees vary from institution to institution, ranging from no charge to a one-time fee for opening the account to an annual fee for maintaining the IRA. Financial institutions also differ in the amount of minimum investment, how often interest is compounded, and the type and frequency of account statement provided. There is no limit to the number of IRAs an individual can open, as long as he or she does not exceed the maximum allowable annual contribution.

Another important factor to consider, in addition to the trustee of the account, is where the IRA funds should be invested. Individuals have a wide range of investment options available to choose from—including bank accounts, certificates of deposit, stocks, bonds, annuities, mutual funds, or a combination thereof—each offering different levels of risk and rates of growth. According to the Entrepreneur Magazine Small Business Advisor, the ideal IRA investment is one that is reasonably stable, can be held for the long term, and provides a level of comfort for the individual investor. Most financial advisors advise against playing the stock market or investing in a single security with funds that have been earmarked for retirement, due to the risk involved. Instead, they recommend that individuals take a more diversified approach with their IRAs, such as investing in a growth-income mutual fund, in order to protect themselves against inflation and the inevitable swings of the stock market.

The decision about where IRA funds should be invested can be changed at any time, as often as the individual deems necessary. Switching to a different type of investment or to a mutual fund with a different objective usually only requires filling out a transfer form from the sponsoring financial institution. Since the IRA simply changes custodians in this type of transaction, and never passes through the hands of the individual investor, it is not subject to any sort of penalty or tax, and it is not considered a rollover.

Despite the number of decisions involved, IRAs nonetheless provide an important means for people to save for their retirement. "The advantages of IRAs far outweigh the disadvantages," as Moore noted. "Earnings for either deductible or nondeductible IRAs grow faster than ordinary savings accounts, because IRA earnings are tax deferred, allowing all earnings to be reinvested. Even when withdrawals are made, the remaining funds continue to grow as tax-deferred assets."

Further Reading:

Blakely, Stephen. "Pension Power." Nation's Business. July 1997.

Crouch, Holmes F. Decisions When Retiring. Allyear Tax Guides, 1995.

The Entrepreneur Magazine Small Business Advisor. Wiley, 1995.

Korn, Donald Jay. "Tax-Deferred Vehicles That Will Last a Lifetime." Black Enterprise. October 2000.

Moore, W. Kent. "Deferring Taxes with Retirement Accounts." In The Guide to Tax-Saving Investing, by David L. Scott. Globe Pequot Press, 1995.

Wiener, Leonard. "How to Keep One Step Ahead: Hot Tips for Turning an Annual Chore into Many Happy Returns." U.S. News and World Report. March 9, 1998.

Wiener, Leonard. "How to Unscramble a Nest Egg." U.S. News and World Report. July 5, 1999.

See also: Retirement Planning

A savings certificate exempt from income tax until the time of withdrawal. There are limits to the amount that can be saved annually under this plan, and there are conditions of withdrawal for maximal interest and tax advantage.

Individual Retirement Account, or IRA, was created in 1974 for those individuals not covered by company pensions. Initially individuals could make tax-deductible contributions of up to $1,500 per annum to an IRA account, but in 1981, a new tax law allowed individuals to make tax-deductible contributions up to $2,000 per annum; the sum was raised to $3,000 for tax year 2002. The Taxpayer Relief Act of 1997 gave employees already in corporate pension programs the ability to contribute monies to their own IRA accounts. IRA contributions can be placed in high-yield investments, with taxation deferred until the money is withdrawn. In most cases, IRA contributions cannot be withdrawn without penalty until after age fifty-nine and a half. Congress did make some exceptions to the rule, however, for qualified education expenses through the creation of an Education IRA and for first-time home purchases. The Taxpayer Relief Act also created the Roth IRA, in which the earnings are tax-free, but there are no tax-deduction benefits for the contributions made each year. Contributions to a Roth IRA are made with after-tax rather than pre-tax dollars, but earnings are tax-free. If certain conditions are met, the earnings are free of Internal Revenue Service penalties. Unlike a traditional IRA, Roth contributions are allowed beyond age seventy and a half.

Bibliography

Bamford, Janet, et al. The Consumer Reports Money Book: How to Get It, Save It, and Spend It Wisely. Yonkers, N.Y.: Consumer Reports, 2000.

Downing, Neil. The New IRAs and How to Make Them Work for You. Chicago: Dearborn Trade, 2002.

A means by which an individual can receive certain federal tax advantages while investing for retirement.

The federal government has several reasons for encouraging individuals to save money for their retirement. For one, the average life span of a U.S. citizen continues to increase. Assuming the average age of retirement does not change, workers who retire face more years of retirement and more years to live without a wage or salary.

Uncertainty over the future of the federal Social Security system is another reason. U.S. workers generally contribute deductions from their paychecks to the Social Security fund. In theory, this money comes back to them, usually upon their retirement. But a substantial number of politicians, economists, and scholars contend that the Social Security fund is being drained faster than it is being filled, and will go broke in a number of years, leaving retirees to survive without government assistance.

Regardless of its future, many people consider the retirement benefits of Social Security to be inadequate, and look for other methods of funding their retirement years. Many employers offer retirement plans. These plans vary in form, but generally offer an employee retirement funds that grow with continued employment. Yet this benefit is not always available to workers. A changing economy has caused some employers to cut back retirement plans or cut them out completely. Often, part-time, new, or temporary workers do not qualify for an employer's retirement plan. And individuals who are self-employed cannot choose this job benefit.

To help people prepare for their retirement, Congress in 1974 established individual retirement accounts (IRAs) ( Employee Retirement Income Security Act [ERISA] [codified in scattered sections of 5, 18, 26, and 29 U.S.C.A.]). These accounts may take a variety of forms, such as savings accounts at a bank, certificates of deposit, or mutual funds of stocks. Initially, IRAs were available only to people who were not participating in an employer-provided retirement plan. This changed in 1981, when Congress expanded the IRA provisions to include anyone, regardless of participation in an employer's retirement plan (Economic Recovery Tax Act [ERTA] [codified in scattered sections of 26, 42, and 45 U.S.C.A.]). The goal of ERTA was to promote an increased level of personal retirement savings through uniform discretionary savings arrangements.

A movement to bolster the federal budget by eliminating many existing tax shelters prompted portions of the Tax Reform Act of 1986 (codified in scattered sections of 19, 25, 26, 28, 29, 42, 46, and 49 U.S.C.A.) and another change in IRA laws. This time, Congress limited some of the IRA's tax advantages, making them unavailable to workers who participate in an employer's retirement plan or whose earnings meet or exceed a certain threshold. Yet, other tax advantages remain, and the laws still allow anyone to contribute to an IRA, making it a popular investment tool.

It is difficult to understand the advantages an IRA offers without understanding a few basics about federal income tax law. Generally, a person calculating the amount of tax she or he owes to the government first determines the amount of income received in the year. This is normally employment income. Tax laws allow the individual to deduct from this figure amounts paid for certain items, such as charitable contributions or interest on a mortgage. Some taxpayers choose to take a single standard deduction rather than numerous itemized deductions. In either case the taxpayer subtracts any allowable deductions from yearly income, and then calculates the tax owed on the remainder.

Taking deductions is only one of the ways a taxpayer can reduce taxes by investing in an IRA. Under current laws, those who do not participate in a retirement plan through work or who earn less than $25,000 a year may receive the greatest tax advantages by contributing to an IRA.

Various plans may constitute employer-maintained retirement plans, such as standard pension plans, profit sharing or stock bonus plans, annuities, and government retirement plans. Someone who does not participate in such a plan — whether by choice or not — is entitled to contribute to an IRA up to $2,000 a year or 100 percent of her or his annual income, whichever is less. The amount contributed during the taxable year may then be taken as a deduction. Married couples may contribute $4,000 to IRAs each year and deduct the full $4,000, if neither spouse participates in an employer-provided retirement plan.

A married taxpayer who files a joint tax return with a spouse who does not work may deduct contributions toward what is called a spousal IRA, or an IRA established for the spouse's benefit. If neither spouse is a participant in an employer-provided retirement plan, up to $4,000 may be deductible.

An individual who participates in an employer's retirement plan may still be entitled to all the tax benefits of an IRA. If a person filing an individual tax return makes less than $25,000 a year, that person may contribute to an IRA and take a full deduction for the amount contributed during the tax year. A taxpayer filing an individual tax return who makes between $25,000 and $35,000 a year may take a partial deduction, the amount of which decreases as income increases. The same rules apply for married taxpayers filing a joint tax return with an income of less than $40,000 in the former instance and between $40,000 and $50,000 in the latter.

Taxpayers who contribute to IRAs usually realize tax benefits even when the law does not permit them to take deductions. That is because income earned on IRA contributions is not taxed until the funds are distributed, which usually occurs at retirement. Income that is allowed to grow, untaxed, for several years, grows faster than income that is taxed each year.

To avoid abuses and excessive tax shelters, Congress has placed limits on the extent to which IRAs can be used as a financial tool. Individuals with IRAs are permitted to make contributions of no more than $2,000 a year, and contributions exceeding that amount are subject to strict financial penalties by the Internal Revenue Service each year until the excess is corrected. The owner of an IRA generally may not withdraw funds from that account until age 59½. Premature distributions are subject to a 10 percent penalty in addition to regular income tax. Taxpayers may be able to avoid this premature distribution penalty by "rolling over," or transferring, the distribution amount to another IRA within sixty days.

An individual may elect not to withdraw IRA funds at age 59½. However, the law requires IRA owners to withdraw IRA money at age 70½, either in a lump sum or in periodic (at least annual) payments based on a life expectancy calculation. Failure to comply with this rule can result in a 50 percent penalty on the amount of the required minimum distribution. Contributions to an IRA must stop at age 70½.

A retirement plan. The “traditional” IRA allows individuals to contribute pretax earnings up to a maximum yearly allowance and to defer income taxes until the money is withdrawn after retirement. The “Roth” IRA allows individuals to contribute aftertax earnings and pay no taxes on future withdrawals. In contrast to a 401(k) plan, an IRA is funded entirely by the individual tax payer.

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An Individual Retirement Arrangement (or IRA) is a retirement plan account that provides some tax advantages for retirement savings in the United States.

Contents 1 Types 2 Funding 3 Valid investments 4 Distribution of funds 5 Bankruptcy status 6 Protection from Creditors 7 Borrowing 8 Double taxation 9 Similar schemes in other countries 10 See also 11 Notes 12 References 13 External links

Types

There are number of different types of IRAs, which may be either employer-provided or self-provided plans. The types include:

• Roth IRA - contributions are made with after-tax assets, all transactions within the IRA have no tax impact, and withdrawals are usually tax-free. Named for Senator William Roth.
• Traditional IRA - contributions are often tax-deductible (often simplified as "money is deposited before tax" or "contributions are made with pre-tax assets"), all transactions and earnings within the IRA have no tax impact, and withdrawals at retirement are taxed as income (except for those portions of the withdrawal corresponding to contributions that were not deducted). Depending upon the nature of the contribution, a traditional IRA may be referred to as a "deductible IRA" or a "non-deductible IRA."
• SEP IRA - a provision that allows an employer (typically a small business or self-employed individual) to make retirement plan contributions into a Traditional IRA established in the employee's name, instead of to a pension fund account in the company's name.
• SIMPLE IRA - a simplified employee pension plan that allows both employer and employee contributions, similar to a 401(k) plan, but with lower contribution limits and simpler (and thus less costly) administration. Although it is termed an IRA, it is treated separately.
• Self-Directed IRA - a self-directed IRA that permits the account holder to make investments on behalf of the retirement plan.

There are two other subtypes of IRA, named Rollover IRA and Conduit IRA, that are viewed as obsolete under current tax law (their functions have been subsumed by the Traditional IRA) by some; but this tax law is set to expire unless extended. However, some individuals still maintain these accounts in order to keep track of the source of these assets. One key reason is that some qualified plans will accept rollovers from IRAs only if they are conduit/rollover IRAs.

What was formerly known as an Educational IRA is now called a Coverdell Education Savings Account.

Starting with the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), many of the restrictions of what type of funds could be rolled into an IRA and what type of plans IRA funds could be rolled into were significantly relaxed. Additional acts have further relaxed similar restrictions. Essentially most retirement plans can be rolled into an IRA after meeting certain criteria, and most retirement plans can accept funds from an IRA. An example of an exception is a non-governmental 457 plan which cannot be rolled into anything but another non-governmental 457 plan.

The tax treatment of the above types of IRAs except for Roth IRAs are substantially similar, particularly for rules regarding distributions. SEP IRAs and SIMPLE IRAs also have additional rules similar to those for qualified plans governing how contributions can and must be made and what employees are qualified to participate.

Funding

• An IRA can only be funded with cash or cash equivalents. Attempting to transfer any other type of asset into the IRA is a prohibited transaction and disqualifies the fund from its beneficial tax treatment.
• Rollovers, transfers, and conversions between IRAs and other retirement accounts can include any asset.
• The maximum for an IRA contribution in years 2006 and 2007 is 100% of earned income or $4,000, whichever is less, for an individual under the age of 50. Individuals aged 50 and older can contribute up to 100% of earned income or $5,000, whichever is less. For 2008 and 2009, the limit is $5,000.
• This limit is for Roth IRAs, traditional IRAs, or some combination of the two. You cannot put more than $5,000 into your Roth and traditional IRA combined ($6,000 for individuals aged 50 or more).

For example, if you are 45 and put $3,500 into your traditional IRA this year so far, you can either put $1,500 more into your traditional IRA or $1,500 in your Roth IRA. There may be an additional administrative step needed so that the trustee which holds the IRA proceeds actually retitles or transfers the $3,500 Traditional proceeds into the Roth category for their internal bookkeeping to survive an IRS audit.

Valid investments

Once money is inside an IRA, the IRA owner can direct the custodian to use the cash to purchase most types of securities, and some non security financial instruments. Some assets cannot be held in an IRA such as collectibles (e.g. art, baseball cards, and rare coins) and life insurance. Some assets are allowed, subject to certain restrictions by custodians themselves. For example an IRA cannot own real estate if the IRA owner receives or provides any immediate gain from/to this real estate investment, for instance as his personal residence or as a property manager who takes personal compensation for this service or adds capital value to the property. The IRS specifically states that custodians may impose their own policies above the rules imposed by the IRS.^[1] It should also be noted that custodians cannot provide advice.

Most IRA custodians limit available investments to traditional brokerage accounts such as stocks, bonds, and mutual funds, and do not permit real estate in an IRA unless it is held indirectly via a security such as a real estate investment trust (REIT). However, self-directed IRA custodians/administrators can allow real estate and other non-traditional assets. They typically charge fees based on asset values. There are certain special restrictions on real estate held in an IRA (the IRA owner cannot benefit from the property in any way, i.e. they cannot use it). Self Directed IRA's allowing non security investments are more complicated and to properly set up may require additional expertise and experience that not all CPAs, attorneys, or other advisors would have.

While certain types of investments are prohibited in an IRA, real estate is not one of them. As a result, real estate owned by an IRA can generate rental income and gain on a sale which escapes immediate taxation. However, the IRA does not get (or, need) the related deductions (e.g., depreciation, mortgage interest,property taxes, etc.).

An IRA may borrow money but any such loan must not be personally guaranteed by the owner of the IRA, and also the loan must be secured solely by assets in the IRA (in other words, a non-recourse loan). Also, the owner of the IRA may not pledge the IRA as security against a debt.

Distribution of funds

Although funds can be distributed from an IRA at any time, there are limited circumstances when money can be distributed or withdrawn from the account without penalties. Unless an exception applies, money can typically be withdrawn penalty free as taxable income from an IRA once the account owner reaches age 59 and a half. Also, non-Roth account owners must begin taking distributions of at least the calculated minimum amounts by April 1st of the year after reaching age 70 and a half. If the minimum distribution is not taken the penalty is 50% of the amount that should have been taken. The amount that must be taken is calculated based on a factor taken from the appropriate IRS table and is based on the life expectancy of the account owner and possibly their spouse as beneficiary if applicable. At the death of the account owner distributions must continue and if there is a designated beneficiary, distributions can be based on the life expectancy of the beneficiary.

There are several exceptions to the rule that penalties apply to distributions before age 59½. Each exception has detailed rules that must be followed to be exempt from penalties. The exceptions include:^[2]

• The portion of unreimbursed medical expenses that are more than 7.5% of adjusted gross income.
• Distributions that are not more than the cost of medical insurance while unemployed
• Disability (defined as not being able to engage in any substantial gainful activity)
• Amounts distributed to beneficiaries of a deceased IRA owner.
• Distributions in the form of an annuity, see Substantially equal periodic payments
• Distributions that are not more than the qualified higher education expenses of the owner or their children or grandchildren
• Distributions to buy, build, or rebuild a first home. ($10,000 lifetime maximum)
• Distribution due to an IRS levy of the plan.

There are a number of other important details that govern different situations. For Roth IRA's with only contributed funds the basis can be withdrawn before age 59½ without penalty (or tax) on a first in first out basis, and a penalty would apply only on any growth (the taxable amount) that was taken out before 59½ where an exception didn't apply. Amounts converted from a traditional to a Roth IRA must stay in the account for a minimum of 5 years to avoid having a penalty on withdrawal of basis unless one of the above exceptions applies.

If the contribution to the IRA was nondeductible or the IRA owner chose not to claim a deduction for the contribution, distributions of those nondeductible amounts are tax and penalty free.

Bankruptcy status

In the case of Rousey v. Jacoway, the United States Supreme Court ruled unanimously on April 4, 2005 that under section 522(d)(10)(E) of the United States Bankruptcy Code (11 U.S.C. § 522(d)(10)(E)), a debtor in bankruptcy can exempt his or her IRA from the bankruptcy estate.^[3] The Court indicated that because rights to withdrawals are based on age, IRAs should receive the same protection as other retirement plans. Thirty-four states already had laws effectively allowing an individual to exempt an IRA in bankruptcy, but the Supreme Court decision allows federal protection for IRAs. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 gave further protection to IRAs. Up to $1,000,000 of IRA assets can be exempt from a bankruptcy estate; this now includes both Traditional and Roth IRAs. The 2005 Act also increased the FDIC insurance limit for IRA deposits at banks.

Protection from Creditors

Many states have laws that prohibit judgments from lawsuits to be satisfied by seizure of IRA assets. For example, IRAs are protected up to $500,000 in Nevada from Writs of Execution.^{[4][citation needed]} However, this type of protection does not usually exist in the case of divorce, failure to pay taxes, deeds of trust, and fraud. Assets in the IRA must have been deposited before a lawsuit exists to receive this protection.^{[citation needed]}

Borrowing

It is a prohibited transaction for the IRA owner to borrow money from the IRA.^[5] Such a transaction disqualifies the IRA from special tax treatment. An IRA may incur debt or borrow money secured by its assets but the IRA owner may not guarantee or secure the loan personally. Income from debt-financed property in an IRA may generate unrelated business taxable income in the IRA.

The rules regarding IRA rollovers and transfers allow the IRA owner to perform an "indirect rollover" to another IRA. This can be used to temporarily "borrow" money from the IRA, once in a twelve month period. The money must be placed in another IRA account within 60 days, or the transaction will be deemed an early withdrawal (subject to the appropriate withdrawal taxes and penalties) and may not be replaced.

Double taxation

Double taxation still occurs within these tax sheltered investment accounts. For example, foreign dividends may be taxed at their point of origin, and the IRS does not recognize this tax as a creditable deduction. There is some controversy over whether this violates existing Joint Tax Treaties, such as the Convention Between Canada and the United States of America With Respect to Taxes on Income and on Capital.

Similar schemes in other countries

• Registered Retirement Savings Plan (RRSP) (Canada)
• Superannuation in Australia
• Individual Savings Account (ISA) (United Kingdom)

See also

• 401(k)
• Roth 401(k)
• Internal Revenue Service
• 401(k) versus IRA comparison matrix
• Self-Directed IRA

Notes

1. ^ "Retirement Plans FAQs regarding IRAs". Internal Revenue Service. http://www.irs.gov/retirement/article/0,,id=111413,00.html. Retrieved 2006-12-21. 
2. ^ Publication 590 (2005), Individual Retirement Arrangements (IRAs)
3. ^ "Rousey Et Ux. v. Jacoway". Supreme Court Of The United States. 2005-10. http://www.supremecourtus.gov/opinions/04pdf/03-1407.pdf. Retrieved 2006-12-21. 
4. ^ http://law.onecle.com/nevada/civil/21.075.html
5. ^ "Publication 590: Individual Retirement Arrangements (IRA)" (PDF). Internal Revenue Service: p. 45. 2008. http://www.irs.gov/pub/irs-pdf/p590.pdf. 

References

• (April 5, 2005). Court shields IRAs from bankruptcy seizure. The Seattle Times
• IRS Publication 590 (2005), Individual Retirement Arrangements (IRAs)

External links

• IRA Online Resource Guide. IRS.gov
• Retirement Plans FAQs regarding IRAs. IRS.gov
• IRA Publication 590. IRS.gov
• IRA vs 401(k)

This entry is from Wikipedia, the leading user-contributed encyclopedia. It may not have been reviewed by professional editors (see full disclaimer)