Are IRAs Qualified Plans?
IRAs are Individual Retirement Accounts. The IRS considers them to be qualified retirement plans. Qualified plans receive special tax breaks and privileges not available with other investment accounts. The plans are also specifically designed to help you save money for retirement and are generally not able to be used for any other purpose. Make sure you understand how these plans work before depositing any money into them.
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Types
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Qualified plans like IRAs meet the requirements of the IRS to defer tax on the investments held within the plan. A traditional IRA allows tax deductible contributions. Withdrawals are taxed at ordinary income tax rates. A Roth IRA is the other type of IRA and allows only after-tax contributions. Withdrawals are not taxed on Roth IRAs. In both types of IRAs, the savings is allowed to grow tax-free inside of the account.
These types of plans differ from non-qualified plans like annuities. Annuities do not allow pre-tax contributions or tax-free distributions. Instead, tax benefits are limited to tax-free buildup of the savings inside of the annuity.
Function
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The function of IRAs is to provide you a savings vehicle for money to be used as retirement income in addition to your Social Security benefit and any pension you may receive from your employer. As a qualified plan, the IRA functions as a tax-shelter. With a traditional IRA, your taxes are being deferred to the future. With a Roth IRA, the tax on your investment earnings are being eliminated altogether. IRAs are not the only types of qualified plans, however. When you contribute to an employer-sponsored plan, called a 401k plan, the amount of your deductible IRA contributions will be affected. For every dollar you contribute to your 401k plan, you lose $1 in tax deductible IRA contributions. You can still contribute to your IRA, but you cannot deduct the contribution from your income on your tax return.
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Benefit
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The benefit of an IRA is that you own the account and can direct the investments in it. You may invest in various investments including stocks, bonds, mutual funds, real estate and precious metals without paying tax on the investments when you sell them inside the account. This allows you to change investments over time without worrying about the tax implications or consequences of your investing activity.
Disadvantage
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The disadvantage to an IRA is that, because the IRA is a qualified plan, the IRS limits contributions to the IRA. Both the Roth and the traditional IRA only accept maximum contributions of $5,000 per year (for those under age 50) and $6,000 (for those under 50 and over). This limits the amount of money you may save for your retirement.
Considerations
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Before contributing to an IRA, make sure that you understand the unique attributes of both types of IRAs. Roth IRAs are ideal if you think tax rates will be higher in the future since no tax is assessed on withdrawals. Traditional IRAs may do better that Roth IRAs if tax rates are lower in the future since traditional IRAs accept pretax contributions, allowing a larger potential retirement savings. If you can't decide between the two, you may invest in both. The maximum combined contribution limit, however, remains $5,000 and $6,000 respectively, regardless of how many IRAs you have.
If you need or want to contribute more money to your retirement than what a qualified IRA plan allows, consider a non-qualified plan. An annuity is an example of a non-qualified plan. Unlike qualified plans, non-qualified plans do not impose contribution limits. You may contribute as much money as you want to the plan, giving you more control over how much you save for your retirement.
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