Why you should have an IRA account

An Individual Retirement Account (IRA) is a tax-deferred retirement savings account.  Tax-deferred means that contribution to an IRA is tax-deductible – you can deduct it from your taxable income.  IRA moneys do not become taxable until you withdraw them from the account, usually at retirement.

Anyone with income and savings who can take advantage of an IRA should do so.  This is a great way to invest and save taxes.  Instead of having to pay taxes on your income now, you can instead invest the money you would have paid in taxes, and earn investment income on it.  You can compound as much income as you can until you withdraw the money, when you will have to pay full income taxes on all money that you withdraw.  It’s like getting to invest the government’s money, and then keeping the profits.

Here I am talking only about “traditional” IRAs, and, as always, the rules permitting you to take advantage of an IRA are very complex.

Here are a few of the most important rules:

  • You can only contribute “taxable compensation.”  This includes wages, salaries, commissions, and self-employment income.  You can even contribute alimony.  But you can’t contribute dividend income, income from investments, or pension income.
  • Contributions are limited to $5,000 per person, $6,000 for individuals over 50.

A quick example:  Suppose that Phil, 22 years old, earned $4,000 in wages during the year.  He can contribute up to  $4,000 to an IRA, and deduct the $4,000 from his earned income.

Another example:  Suppose that Shirley earned $10,000 in wages during the year, and is 53 years old.  She can contribute up to $6,000 to her IRA, and deduct this amount from her earned income.

  • Individuals cannot contribute to an IRA for the year they reach 70 1/2 years of age or older.
  • If you have a retirement plan at work, your IRA deduction may be limited or even nonexistent.
  • You can deduct an IRA contribution made during the year, or even made any date up to the filing deadline of your tax return.  For example, you can deduct an IRA contribution from your 2011 tax return even if you pay the contribution on April 10, 2012 (because this is before the filing deadline).
  • A nonworking spouse can take an IRA deduction from the working spouse’s compensation income.
  • If you contribute money to an IRA, but it doesn’t meet the IRS requirements for tax deductibility, then you should withdraw the money from the IRA before the filing deadline, or else it will be subject to an “excess contributions tax.”
  • You can withdraw money from the IRA when you retire (at least 59 1/2 years of age), at which time it will be taxable as income.  The additional tax for earlier withdrawal is 10%.  However, many provisions permit taxpayers to make early withdrawals (such as buying a home). 

IRA’s are very easy to open.  Just take a check to the bank, and tell them you want to open an IRA.

IRA’s offer many investment options.  You can invest in stocks, bonds, mutual funds, and even commodities.  Speak to your investment advisor and bank rep. about the different options.

Money can be moved from one IRA to another without taxes kicking in.  This is called a “roll over.”

As I wrote before, anyone with income and savings who qualifies for an IRA deduction should make that contribution.

IRA rules are so complicated that I can’t do them justice in a short blog post.  For more information on IRAs, see the IRS’s website.

About Mark P. Holtzman

Chair of Accounting Department at Seton Hall University. PhD from The University of Texas at Austin. Worked at Deloitte's New York Office. BSBA from Hofstra University.

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