IRA Guide: What are Individual Retirement Accounts?

Sep 16, 2010
Carol Finch

What are Individual Retirement Accounts (IRAs)? - Photo by Yello-Dog

This IRA guide gives a brief introduction to Individual Retirement Accounts (traditional, Roth, SEP and SIMPLE IRAs), tax breaks and contribution limits.

Individual Retirement Accounts (IRAs) are used by many people looking to boost retirement savings. Some may use plans on top of/instead of company-led schemes; others may be offered them by their employers. This can be an easy way to save and get tax breaks. This IRA guide gives a basic introduction to plans and how they work.

What are Individual Retirement Accounts (IRAs)?

IRAs are specialist accounts designed to help invest cash for retirement. Some options are taken up by individuals although some variations (the SEP and the SIMPLE IRA) can be offered by employers. Those that qualify to use a plan are allowed to contribute up to a specified limit each year and may be given tax breaks at some point during the process, depending on the option they choose and their circumstances.

IRA Plan Types and Tax Advantages

There are a few different types of plan available to invest savings for retirement. Those most often taken up by individuals include:

Traditional IRAs: Often viewed as the 'base' plan type, these accounts offer tax deductibility options when the individual makes contributions.
Roth IRAs: Roth plans switch tax advantage from the start of the savings process to the end. This effectively means that contributions are taxable rather than withdrawals.

Plans that may be offered by businesses tend to give the same kinds of tax breaks as traditional IRAs. These include:

SEP (Simplified Employee Pension) IRAs: These plans are generally used by small businesses/the self-employed. They are employer-funded but contributions do not have to be made every year.
SIMPLE (Savings Incentive Match Plan for Employees) IRAs: These plans do allow contributions from the employee. Employers can also invest into plans, either by matching worker payments or by making a flat percentage contribution.

IRA Eligibility and Tax Breaks

The rules on who can and can't open an IRA account and the contribution limits may vary depending on the product in question and individual circumstance. Tax deductibility may also vary in some cases, depending on the individual's income and any other retirement accounts they hold.

Traditional IRAs may generally be used by those aged under 70½ who are paid taxable income (or whose spouses are). Roth IRA eligibility is, however, measured on annual income. Eligibility for employer-led SEP and SIMPLE plans may be based on various factors including age, years of service and compensation paid.

What are the Contribution Limits for IRAs?

Again, the amount that can be saved into an IRA each year may depend on the product type. Traditional and Roth IRAs are given the same base limit by the government. For 2010, individuals can, depending on eligibility, save up to $5,000 or their taxable compensation (whichever is smaller) up to the age of 50. Those aged 50+ have an increased limit of $6,000. Contributions can be made into both kinds of accounts but cannot exceed the single base limits. Some may also consider converting a traditional plan into a Roth.

Company-led IRAs have different rules. A SEP plan, for example, can take employer contributions of $49,000 or 25% of income (whichever is smaller) in 2010 for the under-50s. Those aged over 50 have a base limit of $54,500. The annual limit for a SIMPLE IRA is spilt into employer and employee contributions. Employers can put in either a flat 2% of salary or up to a 3% of compensation match. Employees can also save up to $11,500 (under 50) or $14,000 (aged 50+).

Those interested in learning more about retirement savings options may also find the following articles useful:

Sources: CNN Money; IRS. Accessed online 16th September 2010.