IRA Defined
Assets held in individual retirement accounts comprise about one-third of the financial assets accumulated by the 49 million U.S. households that own at least one IRA as of May 2010, according to the Investment Company Institute. The financial industry did not conceive of IRAs; Congress instituted them as a way to help workers save for retirement. Over the years, IRAs have grown into multifaceted investment vehicles.
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History
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In 1974, Congress created traditional IRAs through the Employee Retirement Income Security Act (ERISA). Lawmakers meant for the accounts to serve as a tax-advantaged retirement savings vehicle for employees not covered by workplace retirement plans. With the Taxpayer Relief Act of 1997, legislators devised the Roth IRA. While distinct in the specific tax benefits they provide, as long as you meet Internal Revenue Service (IRS) eligibility guidelines, you can own and contribute to both types of IRAs. Since their creation, Congress has continually voted to raise the maximum amount it allows investors to contribute to IRAs. As of January 2011, that number stands at $5,000 a year for most people and $6,000 a year for most people over the age of 50, according to IRS Publication 590.
Purpose
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While the original intention was to make IRAs exclusively a way to save for retirement, legislation has allowed them to evolve. Generally, the IRS charges a 10-percent tax penalty -- in addition to any regular income tax due -- on IRA withdrawals you take prior to turning age 59 1/2. You can, however, remove IRA money, penalty-free, for several purposes, including to pay for higher education costs, up to $10,000 worth of first-time home buyer expenses, significant unreimbursed medical expenses and medical insurance premiums that accumulate after you have collected unemployment for more than 12 weeks.
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Benefits
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In addition to more latitude regarding early withdrawals, both traditional and Roth IRAs have come with their own distinct tax benefits since their respective inceptions. With a traditional IRA, you can deduct your contributions, up to an annual limit, from your taxable income. Whenever you take out traditional IRA money, however, the IRS taxes the entire distribution at your regular income tax rate. With a Roth, you cannot deduct contributions, but you can remove them at any time, tax- and penalty-fee. When you withdraw Roth money in retirement, it all comes out tax-free, even accumulated earnings, as long as you have held your account for at least five years.
Contributions
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You cannot contribute to a traditional IRA after you turn 70 1/2. In fact, at that juncture, you must begin taking what the IRS calls "required minimum distributions" or pay a 50-percent penalty on the amount of the withdrawal you were supposed to take, but did not. The IRS imposes no such restriction on Roth IRAs. If you make too much money the IRS does not let you contribute to a Roth IRA. While these income limits change with some frequency, the cap, as of January 2011, sits at $176,000 for married filing jointly taxpayers and $120,000 for single filers.
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