Individual Retirement Account (IRA)

Definition

An Individual Retirement Account (IRA) is a trust fund to which any individual employee can contribute for retirement savings. In 2010 and 2011, the contribution limit was up to $5,000 per year. For individuals aged 50 and above, the annual catch-up contribution is up to $1,000. The tax-deductibility of contributions depends on the employee’s income level and eligibility for an employer-sponsored pension plan. If an individual is an active participant in any qualified plan, and their Modified Adjusted Gross Income (MAGI) is $66,000 or more for single filers, or $109,000 or more for married couples filing jointly, they may not take a deduction for the IRA contribution.

Examples

Traditional IRA: John, a single taxpayer, contributes $5,000 to a traditional IRA in 2011. His MAGI is below $66,000, so his contribution is fully deductible from his taxable income.
Roth IRA: Sarah contributes $5,000 to a Roth IRA. Even though her MAGI is higher than the threshold for deduction on a Traditional IRA, she chooses a Roth IRA because qualified distributions will be tax-free.
Catch-Up Contribution: Mark, aged 52, contributes $6,000 to his traditional IRA, which includes the $1,000 catch-up contribution since he is over 50 years old.

Frequently Asked Questions (FAQs)

1. What is an IRA?

An Individual Retirement Account (IRA) is a savings account with tax advantages that individuals can use to save and invest for retirement.

2. Are IRA contributions tax-deductible?

Whether IRA contributions are tax-deductible depends on the individual’s income level, tax filing status, and participation in any employer-sponsored retirement plans.

3. What are the contribution limits?

For 2010 and 2011, the contribution limit was $5,000 annually. Individuals aged 50 and older could contribute an additional $1,000 as a catch-up contribution.

4. What is Modified Adjusted Gross Income (MAGI)?

MAGI is an individual’s adjusted gross income (AGI) with certain deductions added back in. It determines eligibility for various tax benefits, including IRA deductions.

5. What happens if I contribute more than the allowed limit?

Contributions exceeding the limit are subject to a 6% excise tax for each year the excess amounts remain in the IRA.

SEP-IRA

A Simplified Employee Pension Individual Retirement Account (SEP-IRA) is a retirement plan that employers or self-employed individuals can establish. Contributions are made by the employer, and limits are higher compared to traditional IRAs.

Spousal IRA

A Spousal IRA allows a working spouse to contribute to an IRA on behalf of a non-working or low-earning spouse. This helps non-working spouses save for retirement.

Qualified Plan

A qualified plan is an employer-sponsored retirement plan that meets the requirements of the Internal Revenue Code and Employee Retirement Income Security Act (ERISA). Examples include 401(k) plans and profit-sharing plans.

Online References

Suggested Books for Further Studies

The Bogleheads’ Guide to Retirement Planning by Taylor Larimore, Mel Lindauer, Richard A. Ferri, and Laura F. Dogu
IRAs, 401(k)s & Other Retirement Plans: Strategies for Taking Your Money Out by Twila Slesnick and John C. Suttle
Retirement Plans: 401(k)s, IRAs and Other Deferred Compensation Approaches by S. Derrin Watson

Fundamentals of Individual Retirement Account (IRA): Retirement Planning Basics Quiz

### Are Traditional IRA contributions always tax-deductible? - [ ] Yes, for everyone. - [ ] No, they are never tax-deductible. - [x] They may or may not be, depending on income level and participation in other plans. - [ ] Only for people with no other retirement plans. > **Explanation:** The tax-deductibility of Traditional IRA contributions depends on the individual's income level and participation in employer-sponsored retirement plans. ### What is the annual catch-up contribution limit for individuals aged 50 and above? - [ ] $500 - [x] $1,000 - [ ] $1,500 - [ ] $2,000 > **Explanation:** For individuals aged 50 and above, the annual catch-up contribution limit is $1,000. ### Can a non-working spouse contribute to an IRA? - [x] Yes, through a Spousal IRA. - [ ] No, only working individuals can contribute. - [ ] Only if they have other income. - [ ] Only with special permission from the IRS. > **Explanation:** A non-working spouse can contribute to an IRA through a Spousal IRA, allowing the working spouse to make contributions on their behalf. ### What is the MAGI limit for full IRA deduction for single filers in 2010 and 2011? - [ ] $58,000 - [x] $66,000 - [ ] $78,000 - [ ] $89,000 > **Explanation:** If a single filer’s MAGI is $66,000 or more, full IRA deductions may not be available. ### Is a Roth IRA contribution tax-deductible? - [ ] Yes, always. - [ ] No, never. - [x] No, contributions are made with after-tax money, but qualified withdrawals are tax-free. - [ ] Only if the MAGI is below a certain level. > **Explanation:** Roth IRA contributions are not tax-deductible because they are made with after-tax money, but qualified withdrawals are tax-free. ### What is a qualified plan? - [ ] Any personal savings account. - [x] An employer-sponsored retirement plan meeting certain IRS and ERISA requirements. - [ ] A government pension plan. - [ ] A high-yield savings account. > **Explanation:** A qualified plan is an employer-sponsored retirement plan that meets the specific requirements of the Internal Revenue Code and ERISA. ### Are there penalties for excess contributions to an IRA? - [x] Yes, a 6% excise tax applies. - [ ] No penalties at all. - [ ] Only if the excess is not removed within the same tax year. - [ ] Penalties depend on the amount exceeded. > **Explanation:** Excess contributions to an IRA are subject to a 6% excise tax for each year the excess amount remains in the IRA. ### Is MAGI the same as AGI? - [ ] Yes, they are identical. - [x] No, MAGI is AGI with certain deductions added back in. - [ ] Depends on the state. - [ ] Only for tax purposes. > **Explanation:** MAGI is not the same as AGI; it is the AGI with certain deductions added back in. ### How often can individuals make catch-up contributions? - [x] Annually, once they are 50 or older. - [ ] Only in special tax years. - [ ] When they are employed. - [ ] Only in retirement. > **Explanation:** Individuals aged 50 or older can make catch-up contributions annually to their IRA. ### What's the primary benefit of a Roth IRA? - [ ] Immediate tax deduction. - [ ] Lower taxes on contributions. - [x] Tax-free qualified withdrawals. - [ ] Higher contribution limits. > **Explanation:** The primary benefit of a Roth IRA is that qualified withdrawals are tax-free since contributions are made with after-tax dollars.

Thank you for delving into the intricacies of Individual Retirement Accounts and exploring our comprehensive content. Keep enhancing your knowledge in retirement planning!