Retirement and College Savings Plans - Individual Retirement Accounts (IRAs)

In the early 1970s, the U.S. government introduced the Individual Retirement Account to address the growing number of retiring poor in the country. Under IRS rules, any individual who has an earned income during a particular year may contribute $4,000 or 100% (in 2006) of his or her salary total, whichever is less, to Traditional or Roth IRA accounts after meeting certain salary requirements, which are discussed below.

Not all types of investments are permitted within IRAs. Permissible investments include stocks, bonds, mutual funds, annuities, government securities, and gold or silver coins minted by the U.S. Treasury. Other investments such as collectibles, insurance policies, art and other types of coins are not permitted.

Traditional IRAs
Contributions to Traditional IRAs are tax deductible if certain conditions are met. First, the IRA owner may not be covered by an employer-sponsored retirement plan. The account holder must also meet adjusted gross income (AGI) requirements below a certain salary amount, depending on whether he or she is single or married. In 2005, an investor could contribute up to $4,000 to a Traditional IRA account. This amount increases to $5,000 in 2008, and then increases in $500 increments per year thereafter, indexed to the cost-of-living adjustment (COLA).

If the investor is single, participates in a qualified employer-sponsored retirement plan, and earns a salary between $40,000 and $50,000, the deduction is slowly phased out, and he or she can only partially deduct the contribution amount for 2006. Similarly, the deduction is phased out for married couples who have access to a qualified employer-sponsored retirement plan and earn a combined AGI between $60,000 and $70,000.

  • Spousal IRA: Spousal IRAs are available for couples that include a non-working spouse. Up to $8,000 can be contributed - but no more than 100% of the working spouse's income. In this case, the married couple can open two IRAs and contribute $4,000 to each account, for a total of $8,000. The IRA owned by the nonworking spouse is called a spousal IRA.

Look Out!
If one spouse doesn\'t work, and the other spouse earns a yearly income of $7,000, the maximum IRA contribution for the couple will be $7,000. This is because the couple cannot contribute more than 100% of the working spouse\'s income.

  • Required Minimum Distribution (RMD)
: Investors who have not begun to take withdrawals from their Traditional IRAs by the age of 70.5 will incur a tax penalty. The individual who owns the IRA must begin taking required minimum distributions (RMDs) by April 1 following the year in which he or she reaches the age of 70.5. If a person fails to withdraw any amount that should have been distributed under these mandatory minimum requirements, a 50% tax penalty applies to the amount not distributed.

The following information applies to Traditional IRAs only:

  • Earnings are tax-deferred until withdrawn.
  • If deductible contributions are made, 100% of withdrawals are subject to taxation at ordinary income rates.
  • If non-deductible contributions are made, a portion of each withdrawal is not taxable.
  • Contributions may not be made after the IRA owner turns age 70.5, even if he or she is still employed.

Learn more about setting up and withdrawing from a Traditional IRA in the Traditional IRAs tutorial.

In addition, ensure you know when one can take a tax deduction on any participant contribution made within the Traditional IRA Deductibility Limits article.

Roth IRAs
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