What Is an IRA Account and Its Importance?

An IRA, or Individual Retirement Account, is a personal investment account designed to assist in accumulating capital for retirement. It is a tax-deferred retirement savings vehicle that can be set up with a broker or financial institution. IRAs are usually intended for individuals who will not have access to a company-sponsored retirement plan.

401(k) Contributions

The most common form of an IRA is 401(k), in which people make contributions from their current income and receive tax deductions when they do so. Since the 401(k) contributions are deducted before taxes are calculated, these accounts effectively ensure that the individual pays only a minimum amount of tax.

Benefits Associated With IRA

An IRA can be set up as a traditional individual retirement account or as a Roth IRA. In a traditional IRA, all funds contributed are eligible for tax deductions. All interest, dividends, and capital gains are tax-deferred until the account is withdrawn. On withdrawal, traditional IRA contributions may qualify for a tax deduction, and depending on the amount contributed, may also be subject to the age-based 10% penalty if withdrawn before age 59 and a half.

In a Roth IRA, the only contributions to which the federal government’s FICA rate is applied are those made by cash. The Roth IRA itself does not pay any income taxes, and no tax deductions are allowed for contributions. However, when the account owner withdraws money, no taxes are due, regardless of the contribution rate. Therefore, this applies to the principal and any gains that have accrued from interest or dividends.

The IRS Sets Eligibility Requirements for Anyone Wishing to Contribute to an IRA

Contributions may be made until the account owner’s tax filing deadline for that tax year. The IRS also imposes limits on contributions, which vary based on the individual’s income and filing status. These limits ensure that people below the income threshold do not contribute more than they can afford.

While contribution limits are important, other factors are also considered to determine whether someone is eligible to make contributions. These include income and whether another retirement plan at work covers the individual.

To be eligible to participate in an employee’s company-sponsored retirement plan, an employee must work for the employer for at least a year. As of 2014, employees may contribute up to $54,000 ($61,000 if age 50 or older) in a single year and another $6,000 ($6,500 if age 50 or older) each subsequent year. There is no additional limit on contributions for spouses of contributors who make less than the maximum allowable contributions.

When taking distributions from an IRA account, certain rules must be followed. One of these is withdrawal restrictions, limiting when and how often money can be taken out of an IRA.

Conclusively, while this is a good deal for employees and their families, it is not so great for those who contribute the maximum amount possible to the plan each year. For this reason, some tax professionals advise against contributing the maximum amount possible to a 401(k) or 403(b).