The acronym IRA stands for Individual Retirement Account, which is a saving plan that defers tax payment or provides a tax free way of saving for retirement. There are many different types of IRA accounts available depending on your income, financial goals and personal situation and circumstances.
The two most common ones are traditional and Roth IRAs. The traditional Individual Retirement Accounts allow you to contribute savings which earn you a tax deduction on your earnings. You are allowed to contribute up to $4000 a year in to your traditional individual retirement account or more if you are past the age of 50.
The savings you make are taken from your annual income and so reduce the amount of tax you pay from personal income. However, as soon as you withdraw the savings in your IRA, this amount is subject to standard income taxes. It is taxed as an ordinary income. A 10% additional penalty is employed if by the time you are withdrawing the savings, you have not attained at least 59 and a half years of age. Should you use the withdrawn savings to pay for approved higher education costs or to buy a house, then you receive an exception and a waiver is applied to the 10% penalty, with the standard income tax still applying.
Roth individual retirement accounts do not give you a tax deduction for your contributions. However, you get greater flexibility with potentially tax free savings. Any contributions to this account can be withdrawn any time without taxation or any penalties. However, the interest earned on the contribution during the saving period is taxed. If you are covered by a retirement plan, you can still make contributions to a Roth IRA. Just like the traditional IRA, you also enjoy the benefits of no penalties or taxation when purchasing a house or paying for approved higher education costs.
With Roth IRAs, there are income limitations. People who file taxes as individual using single status are eligible, and are allowed full contribution as long as their annual earnings do not exceed $95,000 or $110,000 for the partial contributions. Those who file taxes jointly are allowed full contribution if their joint earnings do not exceed $150,000 and $160,000 for partial contributions. High earners like the high level corporate executives do not need to apply to this type of IRA.
Other IRA types include the Simplified Employee Pension Individual Retirement Accounts (SEP IRAs) and the Savings Incentive Match Plans for Employees (SIMPLE IRAs). These two are group retirement plans. The SEP IRAs are common with self employed people and are similar to the traditional IRAs. They are actually group contribution plans made by an employer, who then puts this in to a traditional IRA. This means that all the regulations of the traditional IRA apply to the SEP IRAs.
The SIMPLE IRAs are simply cheaper options to pension plans and 401(k) plans. However, they offer lower contribution limits compared to most other group plans. So, next time you are asked what is an IRA, now you know the answer.
