Quick Guide To Understanding Individual Retirement Account (IRA)

Quick Guide To Understanding Individual Retirement Account (IRA)

It’s never too early to start preparing for your retirement and one of the best ways to prepare is to set up an Individual Retirement Account (often referred to as an IRA).

Individual Retirement Account (IRA)

The purpose of an Individual Retirement Account (IRA) is to serve as an individual tax-qualified retirement savings plan. Anyone who works, whether as an employee or self-employed, can specify aside a set amount in an IRA, with the earnings on these investments tax-deferred until the date of distribution. 

Different types of individual retirement accounts

There are three various types of IRAs with each of them having its own tax implications and eligibility requirements.

 Traditional IRA

A traditional Individual retirement account (IRA) allows you to deduct the number of your investments from your tax return. Every time you make an investment in a traditional IRA, your taxable income gets reduced by the amount invested by you. This indicates that you will be able to grow your investments without having to pay taxes on the earnings from them until you withdraw them at the time of your retirement.

Roth IRA

A Roth Individual retirement account (IRA) allows you to invest your money after deducting the taxes and then earn tax-free returns till the time of your retirement. Unlike the traditional IRA, you won’t be capable to claim deductions from your taxable income at the time of making the investment in Roth IRA. However, the benefit is that you don’t have to pay any tax at the time of withdrawal of your investment.

Simple IRA

The Simple Individual retirement account (IRA) is meant for self-employed individuals or small business owners. The same taxation rules are applicable for simple IRAs as it is for traditional IRAs. A straightforward IRA allows the small business owners to contribute towards creating a retirement corpus for themselves as well as their employees.

In addition, certain individuals are permitted to deduct all or part of their contributions to the Individual Retirement Account (IRA). Also, as of 1998, specific people can also set up Roth IRAs, to which contributions are not deductible, but from which withdrawals at retirement can be tax-free in the USA.

It doesn’t take much to set up an Individual Retirement Account (IRA). The trustee (or custodian) can be a bank, mutual fund, brokerage house, or other financial organization. 

You cannot be your own trustee. An IRA can be specified and a contribution made after year-end, no later than the due date for filing the income tax return for that year, not including extensions. 

This normally means that you have until March 31st in India of the following year to make the contribution and deduct it from your tax return.

The most you can contribute to an Individual Retirement Account (IRA) in any single year (as of 2006) is the smaller of Rs 4,000 or an amount equal to the compensation included in income for the year. 

Those 50 years old and above will also be allowed to make additional Rs 1,000 catch-up contributions to an Individual Retirement Account (IRA) each year to help them save more for retirement.

The same limit applies even if you have more than one Individual Retirement Account (IRA) or more than one type of IRA. When both you and your spouse have compensation, you can each contribute the maximum, which means Rs 8,000 total (Rs 10,000 if you are both 50 or over). In 2008, IRA contribution limitations will be raised to Rs 5,000, while the catch-up contribution for those 50 years old and above will remain at Rs 1,000. 

You do not have to contribute the full amount permitted every year. You may skip a year or even several years. You may resume making contributions in any succeeding year, but you cannot add more funds to make up for those years when no contribution was made.

Contributions must be from compensation. This can be from wages, salaries, commissions, and additional sources of earned income. Contributions do not include such things as delayed compensations, retirement payments, or portfolio income from interest or dividends.

You can contribute more than the allowable amount, however, a 10-15 percent excise tax penalty will be assessed. 

No contributions may be made to an inherited Individual retirement account (IRA), in a form other than cash, or during or after the year in which the individual reaches age 70.5. 

You must begin taking distributions from an Individual retirement account (IRA) no later than April 1st of the year following the year in which you reach age 65 in India, or the year in which you retire, whichever is later. 

This is a short and general outline of IRAs. The rules are barely different for Roth IRAs, which have their own contribution and distribution limitations. Before setting up an Individual retirement account (IRA), take the time to talk to your banker, accountant, or financial advisor to make sure you have a firm grasp on your choices and set up the IRA that best serves your personal needs. 

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