About Income Retirement Accounts

Sat, 20 Sep 2008 17:17:32 EST

An Income Retirement Account is a retirement savings account set up to provide tax benefits to those who have such an account. Created in 1954 and revised afterwards, they allow an employee to place money into the account either tax-free or tax-deferred, depending on the account type.

The two major types of accounts are traditional IRA's and Roth IRA's. Both have similarities in some areas. The maximum annual total contribution for either type is $5,000 or 100% of the workers' compensation whichever is less, and those who are 50 and older can invest an additional $1,000 per year on top of that. However, the two types are fundamentally different in how taxation is handled within the accounts.

With a traditional IRA, the money contributed is tax-deductible. This means that a contributor gets the advantage of not having his or her contribution counted as taxable income. It is convenient in the short term, as less taxes have to be paid each year, but when the money is withdrawn from the account it is taxed as income. So with this approach a person pays taxes later instead of at the time of contribution.

A caveat of this plan is that in order for the contribution to be tax deductible certain requirements must be met. Also, contributions can only continue until the account holder turns 79 1/2, at which point withdrawals must begin in order to avoid rather hefty penalties (half of the amount which should have been taken out).

A Roth IRA is a more recent type of plan, created in 2006. The biggest difference here is how the money is taxed: money contributed into the account is after-tax money. None of the contribution is tax deductible so income tax payments for those making contributions to such an account would be higher than for someone with a traditional IRA. However, when the money is withdrawn there are no additional taxes which need to be paid.

Having this set up is preferable for those who expect to be in a higher tax bracket at retirement, as taxes paid while contributing are likely to be lower than those paid after retirement. Another advantage to this plan is that there are somewhat lighter restrictions for those wishing to withdraw money penalty-free before reaching the age of 59 1/2: contributed money in the account that hasn't been converted from a traditional IRA can be withdrawn with no penalties on a first-in, first-out basis which means that the oldest investments (usually the ones with the highest appreciation) are the first the get withdrawn in such a scenario. Money converted from a traditional IRA can be withdrawn the same way after the account is five years old.

Most IRA custodians (those who manage the account) only allow the traditional investment types to be purchased with IRA money: stocks, bonds, and mutual funds. Some allow a few more investment options but for the greatest flexibility it is best to open a self-directed IRA account, where the account holder is the one who makes all the investment options.

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About Income Retirement Accounts