IRAs

An individual retirement account or IRA, is a personal savings account which allows you to set aside money for retirement, while offering you tax advantages. Your contributions are made with pre-tax dollars, and amounts in your IRA, including earnings, generally are not taxed until distributed to you, when they are taxed at ordinary income tax rates.

 

To contribute to a traditional IRA, you must be under age 70 1/2 at the end of the tax year and you, or your spouse if you file a joint return, must have taxable compensation, such as wages, salaries, commissions, tips, bonuses, or net income from self-employment. In addition, taxable alimony and separate maintenance payments received by an individual are treated as compensation for IRA purposes. Compensation does not include earnings and profits from property, such as rental income, interest and dividend income or any amount received as pension, annuity income, or deferred compensation.

 

While IRAs are a great retirement tool, you should also ask yourself who should benefit from your retirement assets — you and your family or the federal government? The answer is easy: you and your family, of course. Achieving that goal is more difficult. These days, very few people stay at one job for their entire careers. So, by retirement, you and your spouse may have assets in four or five employer-sponsored retirement plans. How you utilize those accounts at retirement can make a big difference in the amount of assets available to pass on to children or other heirs.

 

First, there's income tax. You'll have to pay federal income tax plus state income tax, if applicable, on the plan distributions you receive during your lifetime. Any remaining tax-deferred contributions and account earnings distributed to your family after your death also will be subject to income tax. Then, there's estate tax. Depending on the size of your estate, your plan assets may be subject to estate tax at rates as high as 46% in 2006.

 

There are also penalties related to IRA distributions that you should be aware of. There is usually a 10% penalty federal penalty for any withdrawals taken before reaching the age of 59 1/2, so it is important not to take premature distributions unless in absolute dire need.