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What is an Individual Retirement Account(IRA)?

Individual Retirement Accounts (IRAs) exist in many forms. The most common type is the IRA or individual retirement annuity to which any person with earnings from employment may contribute. These type of IRA plans are referred to as contributory IRAs. IRAs that are used to receive assets distributed from other retirement plans are called rollover IRAs. Roth IRAs combine the features of a regular IRA and a savings plan to produce a hybrid that adheres to its own set of rules. Whereas, SEPs and SIMPLE IRAs are technically IRAs even though their rules are quite similar to those of qualified plans.

An IRA, like the trust under an employer’s qualified plan, is exempt from tax pursuant to Internal Revenue Code Section 408(e)(i), and an individual maintaining an IRA usually is not taxed on principal or earnings of the account or annuity until they are distributed by the trustee, custodian, or insurance company. A deductible contribution to an IRA thus offers the same tax advantage as an employer’s contribution to a qualified plan: deferral of taxation of the contributed funds and investment returns thereon until the funds are withdrawn at retirement.

What is a Traditional Contributory IRA?

Enacted in 1974 and expanded and curtailed by successive legislative changes over the ensuing years, the IRA rules were designed by Congress to stimulate savings by employees not covered by qualified plans of their employers.

In general, if you have income from working for yourself or someone else, you may establish and contribute to an IRA. The IRA can be a special account that you can set up with a bank, brokerage firm, or other institutional custodian. Alternatively, it can be an individual retirement annuity that you can purchase from an insurance company.

You may contribute a maximum of $5000 each year, or $6000 if you will reach the age of 50 by the end of the year. If you are not covered by an employer’s retirement plan, you may take a deduction on your tax return for your contribution. However, if you are covered by an employer’s plan, your IRA may be fully deductible, partly deductible, or not deductible at all depending on how much gross income you have.

The comparatively low ceiling on IRA deductions is probably intended to keep IRAs from becoming a serious alternative to qualified plans for highly compensated employees. With a higher ceiling, shareholder-employees and other highly compensated employees of closely held enterprises could arrange for higher salaries and establish their own retirement programs, thus reducing the company’s incentive to create a nondiscriminatory qualified plan covering rank and file employees as well as insiders.

IRAs can be invested in securities, real estate, or virtually any other asset except life insurance, art works, precious metals, and other collectibles. An IRA, however, is subject to the Unrelated Business Income Tax (UBIT) if it engages in a trade or business, and an IRA contributor is subject to some of the prohibited transaction rules of Internal Revenue Code Section 4975, imposing excise taxes on self-dealing transactions.

IRAs must generally be nontransferable, but a transfer of an individual’s interest to a former spouse under a divorce decree or written instrument incident thereto is permitted, is not a taxable event, and the transferred asset is treated thereafter as maintained for the benefit of the transferee spouse.

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