Now that you know enough about the Roth IRA to be dangerous (see last week's DailyWorth on the subject), you're done researching retirement plans. Whoa. Stop right there. The Roth IRA is just the tip of the retirement-fund iceberg. There are a zillion different types of individual retirement accounts (IRAs), but you only need to be concerned with five, the most popular of which is the traditional IRA. A traditional Individual Retirement Account, or IRA, is an account to which you, the taxpayer can make tax-deductible contributions from your earned income (otherwise known as your salary or wages). Funds deposited and earned in that account will be available to you at the age of 70 ½, which, in case you noticed, is 4 ½ years AFTER standard retirement age in the U.S. But who's counting?
There are limits as to how much you can sock away on an annual basis, and you have to meet certain requirements for your contributions to be tax-deductible. Say, for example, that your employer offers an employer-sponsored 401K. As your salary increases, you can kiss the tax deductibility of your IRA contributions goodbye. See, there are some advantages to a recession. No raise, no problem with your IRA.
Your IRA lives under the care of a custodian institution - a bank or brokerage firm, for example - that invests your IRA funds in different vehicles, such as certificates of deposit, mutual funds, stocks. Any transactions in the account - that includes interest, dividends and capital gains - aren't taxed until you start withdrawing from the account, which you HAVE to do by April 1 of the year after you turn 70 ½, assuming that you celebrate a half birthday.
If you don't tap into your IRA funds when you're supposed to, the Feds will slap a 50% penalty on whatever amount is still in the account. Ouch. And even if you behave like a good little taxpayer and do start siphoning funds from your IRA, those withdrawals - known as "distributions" in IRA jargon - are subject to federal income tax because they've been growing, tax-deferred, for all those years. One last thing: Don't even think of borrowing from IRA. Do it, and the IRS will hunt you down, disqualify your plan and tax you on the assets. Double ouch.
Uncle Sam's grasping habits aside, a traditional IRA is a useful way to save money. The real question is: Who came up with the 70 ½-years-old rule and why? Why not just 70 or 71?
In addition to the garden-variety IRA, there are a few more IRAs worth noting:
- SIMPLE IRA, or Savings Incentive Matching Plan for Employers. This is a small-business employee IRA. The employee can contribute up to $8,000 a year, and the employer will match a portion of it.
- SEP IRA, or Simplified Employee Pension. This is a traditional IRA set up by a company for its employees. The employer can contribute up to 25% or an employee's annual salary, or $40,000 - whichever comes first.
- Individual Retirement Annuity. This is just a traditional IRA or a Roth IRA set up through a life insurance company. You have to buy a special annuity contract to participate.
- EIRA, or Educational IRA. This is a non-retirement IRA. Instead of squirreling it away for your golden years, this IRA permits the beneficiary to pay for higher education, if the account was established on or after January 1, 1998. Deposits aren't tax-deductible, BUT any deposits and earnings that you take out aren't subject to any additional penalties or taxes. Here's the hitch: There are no limits on the beneficiary's income, but the beneficiary has to be 18 years old or younger. So how much income could they have anyway?
Confused yet? Learn more about all the IRAs you didn't know existed at http://www.bankrate.com/brm/itax/news/20010221a.asp.
I found yesterday's email on bonds confusing. The first few sentences suggest that bonds are risky, but then you provide information about purchasing bonds. What's the point of the article? If you're saying that bonds are an investment to consider but that we should consider them knowing that they are risky too, you should state that. - Ellen, civil rights attorney
Thanks for calling us out on our lack of clarity. Our point was, bonds aren't the be-all, end-all moneymaker that many say they are. But that doesn't mean they're not worth buying. It's just a caveat emptor (buyer beware). Be aware and be smart when shopping for bonds.
Independent research yes, but did you know you have to join for a fee? They don't even tell you what the fee is? - Caroline
Doh! We apologize. We'll vet our sources better in the future, and find better ones for "Bondage, the Sequel."
DailyWorth on SELF.com
DailyWorth gets a shout-out on SELF.com (thank you MP Dunleavey).