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What is an IRA?
The basics
Tax benefits
Early withdrawal penalty
Kinds of IRAs
Investment options

The basics

If you're interested in socking away a little more for retirement, you might want to consider opening an individual retirement account (IRA). IRAs are retirement plans available to people under age 70-1/2 who receive taxable income such as salaries, tips, commissions, and even taxable alimony. Nonworking spouses may have IRAs as long as their husband or wife does have taxable income.

With some exceptions, the most you can currently contribute to an IRA is $2,000. That maximum is expected to rise to $4,000 in 2003 and $5,000 in 2004. You can't contribute more than you earn, so if you made $1,500 that would be all you could contribute. If you have set up an IRA, you do not have to contribute to it each year, nor does the law set a minimum amount if you do decide to make a contribution. (Your financial institution may have a minimum.) Whether the contributions can be made on a pre-tax basis depends on rules including your income and whether you are covered under another qualified retirement plan.

Tax benefits

You do not owe any taxes on your earnings until you make withdrawals from your account. If you have made pre-tax contributions to your account, these are subject to ordinary income tax when you withdraw the money. Also, a 10% penalty tax is due on amounts withdrawn before age 59-1/2. In the case of Roth IRAs, the earnings are tax-free even at withdrawal because contributions are made with after-tax dollars.

Contributions to a traditional IRA may or may not be deductible in the tax year made, depending on your income tax filing status, adjusted gross income (AGI), and eligibility to participate in a tax-qualified retirement plan through employment.

If you do belong to a qualified retirement plan, your IRA contributions are not deductible unless your AGI falls within a certain range. These ranges vary from year to year.
Currently the ranges are increasing gradually through 2007, when they will be $50,000-$60,000 for single filers and $80,000-$100,000 for joint filers.

Working spouses who are not covered by a retirement plan may deduct up to $2,000 in IRA contributions each year even if their spouse is covered by such a plan. The deduction begins to decline, however, when the couple's joint AGI reaches a certain point.

Early withdrawal penalty

You may withdraw from your IRA at any time, but if you make withdrawals before age 59-1/2 (except for Roth and Education IRAs), you'll owe Uncle Sam a 10% penalty in addition to taxes if the contributions were pre-tax. You must begin to withdraw from your IRA no later than April 1 of the year following the year you reach age 70-1/2. If you don't take minimum withdrawals at that age, you face a 50% penalty.

There are several exceptions to the 10% penalty for early withdrawals, including withdrawals that occur because of the IRA owners' disability, death or need to pay medical expenses that exceed 7-1/2% of an individual's AGI, to pay for a first-time house purchase or certain educational expenses plus a few others.

Kinds of IRAs

There are currently 11 different kinds of IRAs, including a conduit (or rollover) IRA, which is set up to hold tax-deferred amounts from an employer's qualified plan. For example, if you have a 401(k) plan with your company and leave that company, you can have your vested account transferred directly to a conduit IRA. This will postpone tax.

When you begin work for another employer with a qualified plan, you may be able to transfer the money from the conduit IRA into that qualified plan and continue to postpone tax. This is called a rollover.

Investment options

You can invest your IRA money in any way you choose from traditional savings accounts to stock and bond purchases. You can also change your investments when you like without paying any taxes on your gains. Many financial service companies offer IRAs, including banks, mutual fund and brokerage firms. Be careful of trading fees, however. Since you can only contribute $2,000 a year, trading fees could eat up a lot of your savings if you make frequent trades.

IRAs are one of several good ways to save for retirement, but they can be a bear to manage if you open several at different institutions over the years. Also when you begin to make decisions about withdrawals, having many different accounts will make the process very complex, so for simplicity's sake you might want to consider opening your IRA accounts with one institution that offers many different kinds of investments. That way you have investment options plus the convenience of one statement.