What is an IRA? | Wealth Building

By DanielBeckett
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IRAs are a form of retirement fund that allow US citizens to lower their tax owed. IRAs can either be offered by employers or created by individuals. Since funds are contributed directly to IRAs, most are tax free under US tax law.

Types of IRAs

Individual Retirement Accounts come in a variety of forms, each with different distinguishing characteristics. Traditional IRAs are the most generic form of IRA, and are generally what people refer to when they don't specify an IRA type. Roth IRAs, on the other hand, allow tax free withdrawals, as money is taxed as it is deposited.

Though Traditional and Roth IRAs are the most popular, there are several other forms of IRAs, including SEP IRAs (which are often used by smaller companies or self-employed people), SIMPLE IRAs (more similar to 401(k) plans than other IRAs), and Self-Directed IRAs (which allow an individual to manage their own fund).

Previous versions of US tax law included other forms of IRAs. Rollover, Conduit, and Educational IRAs are no longer available for formation under current US tax law.

Except for Roth IRAs, all IRAs are taxed at withdrawal.

Paying into IRAs

Only money can be deposited in IRAs. At the moment, $5000 is the annual contribution limit for most people, though anyone over 50 years of age can deposit an additional $1000. However, no one can give more than their annual income.

Money can almost always be transferred between IRAs and other retirement funds. There are a few exceptions, but in general IRAs and other retirement accounts can accept funds from one another freely.

Getting the Money Out

Generally there are strong penalties for withdrawing funds from retirement plans with tax benefits, and IRAs are no exception. In this case, funds cannot be withdrawn without significant penalties before the holder reaches the age of 59 and 1/2. Exceptions allowing withdrawals include educational expenses, if the holder becomes disabled, or the first time the holder buys a house.

There are also penalties associated with holding funds in IRAs too long - if no withdrawals are made before the holder reaches 70.5 years, funds in the IRA will begin to be lost.

IRA Holdings

With the exception of Self-Directed IRAs, IRAs are generally managed by designated managers. IRAs are usually composed of securities. Some other assets are often allowed, but many managers discourage their inclusion.

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