What is an individual retirement account (IRA)?

An Individual Retirement Arrangement (IRA) is a retirement savings plan that allows you to contribute a portion of your earned income each year. This is reported on Form 1099-R.

Two Types of IRAs

There are two common types of IRAs, a Traditional IRA and a Roth IRA. Traditional IRAs are common if your income exceeds the amount to qualify for a Roth IRA, eligible for the tax deduction and expect to be in a lower tax bracket in retirement. Roth IRAs are common for individuals with a Modified Adjusted Gross Income (MAGI) below the limit, want tax-free withdrawals and avoid minimum distributions, or expect to be in the same or higher tax bracket in retirement. Read more about the differences here.

Which IRA is tax deductible?

Traditional IRAs are tax deductible but Roth IRAs are not tax deductible. There are limitations to contributing to your IRA (adjusted by COLA annually). You cannot contribute more than your taxable compensation for the year. Your contribution limit does not apply to rollover contributions and qualified reservist repayments.

There are benefits to contributing to an IRA.

If you receive payments before retirement, you can roll them over by moving your retirement savings from your retirement plan at work (401k, 403b, 457 plan) into another retirement savings account (IRA) within 60 days to avoid paying income taxes.

For example, you’ve been working for a company for 40 years, with a 401(k).  You’ve contributed to the company’s employer-sponsored retirement plan. There comes a time where you must retire and you need money. Therefore, you must transfer your money from your retirement plan into your new savings account within 60 days to avoid income tax and additional fees. Here are some options.

  1. Choose an IRA and roll over. You can consolidate distributions and contributions in one IRA but Traditional and Roth IRA plans are separate.
  2. Leave funds in your existing plan. You cannot leave funds in an existing account if you have less than the minimum amount required for the plan. 
  3. Transfer funds from your old 401(k) to new IRA.
  4. Withdraw. If you withdraw before retirement age, you will owe taxes and get an early distribution penalty. 

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