Individual Retirement Account

 An Individual Retirement Account (or IRA) is a retirement plan account that provides some tax advantages for retirement savings in the United States.  The individual retirement arrangement and related vehicles were created by amendments to the Internal Revenue Code of 1954 (as amended) made by the Employee Retirement Income Security Act of 1974 (ERISA), which enacted (among other things) Internal Revenue Code sections 219 (26 U.S.C. § 219) and 408 (26 U.S.C. § 408) relating to IRAs.

Types of IRA's

There are a number of different types of IRAs which may be either employer-provided or self-provided plans. The types include:

1. Roth IRA - contributions are made with after-tax assets, all transactions within the IRA have no tax impact, and withdrawals are usually tax-free. Named for Senator William Roth.
2. Traditional IRA - contributions are often tax-deductible (often simplified as "money is deposited before tax" or "contributions are made with pre-tax assets"), all transactions and earnings within the IRA have no tax impact, and withdrawals at retirement are taxed as income (except for those portions of the withdrawal corresponding to contributions that were not deducted).
3. SEP IRA - a provision that allows an employer (typically a small business or self-employed individual) to make retirement plan contributions into a Traditional IRA established in the employee's name, instead of to a pension fund account in the company's name.
4. SIMPLE IRA - a simplified employee pension plan that allows both employer and employee contributions, similar to a 401(k) plan, but with lower contribution limits and simpler (and thus less costly) administration. Although it is termed an IRA, it is treated separately.
5. Self-Directed IRA - a self-directed IRA that permits the account holder to make investments on behalf of the retirement plan.
   There are two other subtypes of IRA, named Rollover IRA and Conduit IRA, that are obsolete under current tax law (their functions have been subsumed by the Traditional IRA) but this tax law is set to expire unless extended. What was formerly known as an Educational IRA is now called a Coverdell Education Savings Account.

Starting with the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), many of the restrictions of what type of funds could be rolled into an IRA and what type of plans IRA funds could be rolled into were significantly relaxed. Additional acts have further relaxed similar restrictions. Essentially most retirement plans can be rolled into an IRA after meeting certain criteria, and most retirement plans can accept funds from an IRA.

The tax treatment of the above types of IRAs except for Roth IRAs are substantially similar, particularly for rules regarding distributions. SEP IRAs and SIMPLE IRAs also have additional rules similar to those for qualified plans governing how contributions can and must be made and what employees are qualified to participate.

Funding

• An IRA can only be funded with cash or cash equivalents. Attempting to transfer any other type of asset into the IRA is a prohibited transaction and disqualifies the fund from its beneficial tax treatment.
• Rollovers, transfers, and conversions between IRAs and other retirement accounts can include any asset.
• The maximum for an IRA contribution in years 2006 and 2007 is 100% of earned income or $4,000, whichever is less, for an individual under the age of 50. Individuals aged 50 and older can contribute up to 100% of earned income or $5,000 whichever is less.
• This limit is for Roth IRAs, traditional IRAs, or some combination of the two. You cannot put more than $4,000 into your Roth and traditional IRA combined ($5000 for individuals aged 50 or more).

For example, if you are 45 and put $3,500 into your traditional IRA this year so far, you can either put $500 more into your traditional IRA or $500 in your Roth IRA. However, because this is still before the filing deadline (April 17, 2007) for calendar year 2006, the cash method taxpayer could get the full $4000 limit for the Roth by simply calling the $3,500 a Roth and not claiming the $3,500 above the line (i.e., reduces AGI) deduction and making the remaining $500 a Roth. There may be an additional administrative step needed so that the trustee which holds the IRA proceeds actually retitles or transfers the $3500 Traditional proceeds into the Roth category for their internal bookkeeping to survive an IRS audit.

Valid Investments

Once money is inside an IRA, the IRA owner can direct the custodian to use the cash to purchase most types of securities, and some non security financial instruments. Some assets cannot be held in an IRA such as collectibles (e.g. art, baseball cards, and rare coins) and life insurance. Some assets are allowed, subject to certain restrictions by custodians themselves. For example an IRA cannot own real estate if the IRA owner has any involvement with that real estate, for instance as his personal residence or as a property manager (or if a relative fills one of these roles). The IRS specifically states that custodians may impose their own policies above the rules imposed by the IRS.[1] It should also be noted that custodians cannot provide advice.

Most IRA custodians limit available investments to traditional brokerage accounts such as stocks, bonds, and mutual funds, and do not permit real estate in an IRA unless it is held indirectly via a security such as a real estate investment trust (REIT). True self-directed IRA custodians/administrators permit real estate and other non-traditional assets. They may be found via a web search. They typically charge fees based on asset values. There are certain special restrictions on real estate held in an IRA (the IRA owner cannot benefit from the property in any way, i.e. they can not use it). There are many companies who educate clients on the rules for self-directed IRA investors who need assistance. Self directed IRA's are more complicated and may require additional expertise and experience to properly set up. Not all CPAs, attorneys, or other advisors would have that type of experience.

An IRA may borrow money but any such loan must not be personally guaranteed by the owner of the IRA, and also the loan must be secured solely by assets in the IRA (in other words, a non-recourse loan). Also, the owner of the IRA may not pledge the IRA as security against a debt.

Distribution of Funds

Although funds can be distributed from an IRA at any time, there are limited circumstances when money can be distributed, or withdrawn from the account, without penalties. Unless an exception applies, money can typically be withdrawn penalty free as taxable income from an IRA once the account owner reaches age 59 and a half. Also, non-Roth account owners must begin taking distributions of at least the calculated minimum amounts by April 1st of the year after reaching age 70 and a half. If the minimum distribution is not taken the penalty is 50% of the amount that should have been taken. The amount that must be taken is calculated based on a factor taken from the appropriate IRS table and is based on the life expectancy of the account owner and possibly their spouse as beneficiary if applicable. At the death of the account owner distributions must continue and if there is a designated beneficiary, distributions can be based on the life expectancy of the beneficiary.

There are several exceptions to the rule that penalties apply to distributions before age 59½. Each exception has detailed rules that must be followed to be exempt from penalties. The exceptions include:

1. Unreimbursed medical expenses that are more than 7.5% of adjusted gross income.
2. Distributions that are not more than the cost of medical insurance while unemployed
3. Disability (defined as not being able to engage in any substantial gainful activity)
4. Amounts distributed to beneficiaries of a deceased IRA owner.
5. Distributions in the form of an annuity, see Substantially Equal Periodic Payments
6. Distributions that are not more than the qualified higher education expenses of the owner or their children or grandchildren
7. Distributions to buy, build, or rebuild a first home. ($10,000 lifetime maximum)
8. Distribution due to an IRS levy of the plan.

There are a number of other important details that govern different situations. For Roth IRA's with only contributed funds the basis can be withdrawn before age 59½ without penalty (or tax) on a first in first out basis, and a penalty would apply only on any growth (the taxable amount) that was taken out before 59½ where an exception didn't apply. Amounts converted from a traditional to a Roth IRA must stay in the account for a minimum of 5 years to avoid having a penalty on withdrawal of basis unless one of the above exceptions applies.

Self Directed IRA

A Self-Directed Individual Retirement Account is an IRA that requires the account owner to make investment decisions and investments on behalf of the retirement plan. IRS regulations require that either a qualified trustee, or custodian hold the IRA assets on behalf of the IRA owner. Generally the trustee/custodian will maintain the assets and all transaction and other records pertaining to them, file required IRS reports, issue client statements, assist in helping clients understand the rules and regulations pertaining to certain prohibited transactions, and perform other administrative duties on behalf of the Self-directed IRA owner for the life of the IRA account. Self-directed IRA accounts are typically not limited to a select group of asset types (e.g., stocks, bonds, and mutual funds), and most truly self-directed IRA custodians will permit their clients to engage in investments in most, if not all, all of the IRS permitted investment types (an almost unlimited array of possibilities including foreign real estate). Some of the additional investment options permitted under the regulations include, but are not limited to, real estate, stocks, mortgages, franchises, partnerships, [private equity] and tax liens. Self-directed IRAs, by allowing a wide range of investment choices, improve the account owner's opportunities to diversify their IRA portfolio(s). Some investments, such as life insurance or collectibles as defined by the Internal Revenue Service, are not permitted in IRAs. Also, if real estate or any other investment asset held in a self-directed IRA has been employed for personal use, or to gain any other personal benefit (other than a return for the IRA), in the view of the IRS or the Department of Labor, the IRA(s) may become immediately taxable. In addition, if the IRA owner is younger than 59 1/2, the IRA will be subject to an early withdrawal penalty of 10%. It is important, therefore, that those interested in self-directed IRAs work with qualified and experienced IRA custodians.

Contributions limits for both in 2006 and 2007 are $4,000 (or $5,000 for those age 50 and above.) A traditional IRA comes in two flavors: deductible and nondeductible. To see if you qualify for a deductible IRA, which lets you deduct all or part of your contributions from your taxable income, use the following guidelines: If you have no retirement plan at work and you're under 70-1/2, you can invest in a deductible IRA and deduct the entire amount from your taxes. If you have a 401(k) or other retirement plan at work, you may fully or partially deduct your contribution only if your adjusted gross income (AGI) qualifies. In 2006, your AGI cannot exceed $60,000 if you're single or head of household, or $85,000 if you're married and filing jointly. If you're not covered by a retirement plan, but your spouse is, you may qualify for a full or partial deduction if you file jointly and your AGI is below $160,000. (The same rule applies if you're a non-working spouse of someone covered by a retirement plan at work.) If you're not eligible to contribute to a deductible IRA, you may be eligible to contribute to a Roth IRA if your AGI is below $110,000 if you're single or $160,000 if you're married filing jointly. If you make too much to qualify for a Roth IRA and are not eligible for a deductible IRA, a nondeductible IRA is a valid option. Your contribution won't be deductible, but at least your savings will grow tax-deferred. So which IRA is best for you? The nondeductible is the least attractive, so open one only if you don't qualify for the other two. The choice between a deductible and a Roth is more difficult, but generally you're better off in a Roth if you expect to be in a higher tax bracket when you retire.