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What Is An Individual Retirement Arrangement?

April 12, 2012 | Comments: 0 | Views: 173

IRA is short for Individual Retirement Arrangement. It is a special kind of retirement arrangement that was introduced in 1974, allowing individuals to set up special accounts with certain tax benefits for themselves and their beneficiaries. The arrangement always includes both an individual retirement account and an individual retirement annuity. The annuity or endowment contract is purchased from a life insurance company, along with a trust or custodial account. For those who can afford this type of savings plan, there are many benefits to enjoy.

How It Works

Any taxpayer can set up an IRA, into which they deposit up to $5,000 per year, which is a great deal more than the initial limit of $1,500 when this type of account was first introduced. Individual taxpayers can also contribute as much as $250 on behalf of a spouse who is not currently employed. The money in that account is not included in the individual's taxable income, so it reduces one's tax liability. Since 1981, this type of retirement plan has been restricted to individuals under the age of 70½.

Main Types of IRAs

There are several different types of Individual Retirement Accounts, including Traditional, Roth, SEP, Simple and Self-Directed IRAs. These are explained in further detail below:

  • Traditional IRA - The traditional arrangements allow individuals to deposit money before being taxed, although the money will be taxed as income when withdrawn after retirement age.
  • Roth IRA - Contributions to this type of IRA have been taxed, although any transaction made within the arrangement has no tax impact and the withdrawals made after retirement are not taxed.
  • SEP IRA - These IRAs enable small business owners to make contributions to their employees' IRAs (or their own, if they're self-employed).
  • Simple IRA - This type of IRA includes incentives for employers to match employee contributions, similar to a 401(k), but with smaller contribution limits.
  • Self-Directed IRA - Account holders can invest on behalf of their retirement plan with this type of IRA.

Other Types of IRAs

There are a few other IRA subtypes that don't quite fit into any of these categories, such as Conduit and Rollover IRAs, which have become somewhat outdated. There is also what is called a Coverdell Education Savings Account, which used to be known as an Educational IRA, and is intended for individuals who want to save for a loved one's education in the future. It functions much like a Traditional Individual Retirement Account.

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