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10 must-know IRA terms

An individual retirement account is an excellent resource for growing your retirement portfolio. You enjoy the benefits of compounding growth and tax savings. But with nearly a dozen varieties of IRAs available it can get a bit confusing. Understanding these terms will give you an investing head start.

AGI (Adjusted Gross Income) -- Used to calculate federal income tax, AGI includes all the income you received over the course of the year such as wages, interest, dividends and capital gains minus things such as business expenses, contributions to a qualified IRA, moving expenses, alimony and capital losses.

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Contribution -- IRA contributions are limited to $3,000 a year for those younger than 50 and $3,500 a year for those 50 and older. Contributions are classified as either tax deductible or nondeductible.

Deductible/nondeductible -- Contributions to a traditional IRA are tax deductible if you are not covered by your employer's retirement plan. Even if you do participate in a company pension or 401(k) plan, you still may be able to deduct contributions to a traditional IRA depending upon your income and filing status. Contributions to a Roth IRA are not deductible.

Education IRA -- In 2001, these plans were renamed the Coverdell Education Savings Account in honor of the late U.S. Sen. Paul Coverdell. Individuals can make annual contributions of up to $2,000 per child into an account that's exclusively for helping to pay higher education costs. The money contributed to a Coverdell account doesn't count against the $3,000 ($3,500 if 50 and older) annual total individuals may contribute to their combined individual IRAs. The earnings and withdrawals from a Coverdell account are tax-free, but you can't deduct the contributions from your income tax.

IRA (Individual Retirement Account) -- IRAs are retirement accounts with tax advantages. Individuals may contribute up to $3,000 ($3,500 if 50 or older) annually to an IRA as long as they have earned $3,000 in that year (i.e. you can't pad it with unearned money). The investment grows tax-free until it's withdrawn, usually after age 59½. Money withdrawn before age 59½ will usually get hit with a 10 percent penalty, but there are some exceptions.

MAGI (Modified Adjusted Gross Income) -- For the purpose of determining your contribution limit some people use their AGI increased by certain exclusions from your income. Examples of exclusions to income include foreign-earned income and housing costs of U.S. citizens or residents living abroad and income from sources within Puerto Rico, Guam or American Samoa.

Required minimum distribution -- Generally, a traditional IRA owner must begin taking money out of the account by April 1 of the year after he or she turns 70½. The amount is a minimum distribution determined by the account holder's age and life expectancy. The IRS has established simplified tables that a traditional IRA owner can use to figure the required distribution. If required payments are not made on time, the IRS will collect an excise tax. Roth IRAs aren't subject to minimum distribution requirements until after the Roth owner dies.

Rollover -- This is the term used when transferring assets from one tax-deferred retirement plan to another.

Roth IRA -- The most notable thing about a Roth is withdrawals are tax-free if the account has been open for at least five years and you're at least 59½ when you start to withdraw money. Contributions to a Roth are not tax deductible. The Roth is named for Sen. William Roth Jr., chairman of the Senate Finance Committee.

Tax and penalty-free withdrawals -- You can take money out of your IRA tax-free and penalty-free as long as you repay the full amount within 60 days. It's a good way to give yourself an interest-free loan. You can only do this once every 12 months.

Bankrate.com's corrections policy
-- Posted: Jan. 24, 2003
 
 
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