Basics of IRAs

Roth IRAs

There are several prominent differences between the traditional IRA and the Roth IRA. Contributions to a Roth are never tax-deductible, but the earnings grow tax free. You may withdraw your contributions at any time without penalty. In addition, there is no requirement that you take minimum distributions at any age.

In general, Roth contribution limits mirror the limits set for traditional IRAs. As long as you have earned income equal to the amount of your contribution and meet the income restrictions, you can open a Roth even if you have a traditional IRA and an employer-sponsored 401(k).

The Roth IRA is a convenient way to give yourself access to tax-free money when you retire. If you're a smart investor and manage your account properly, you could reap an enormous windfall. Just about any brokerage firm, bank, credit union or mutual fund company will help you open a Roth IRA.

There are two ways to get a Roth started -- open a new account and fund it with new money or convert assets from a traditional IRA to a Roth. Converting a traditional IRA to a Roth means you have to first pay any taxes that are owed on the investments that will be converted. A key aspect when considering whether to convert a traditional IRA to a Roth is how you'll pay the tax on the earnings from the traditional IRA. The earnings will be taxed as ordinary income. If you need to use the IRA itself to pay the tax, it may not be a smart idea to convert. You don't have to convert your entire traditional IRA at once. You can do it piecemeal and just convert as much as you can comfortably afford to pay the tax on.

Self-directed IRAs

An IRA that is set up with a brokerage is said to be "self-directed." You have the responsibility of deciding how the money will be invested -- stocks, bonds, mutual funds, certificates of deposit, even real estate.

You can open a self-directed IRA with any brokerage. Just visit the brokerage's Web site and follow the instructions. The account can be funded with new money or, if you leave a company, you can arrange to have the proceeds from your company-sponsored retirement plan rolled over into an IRA. If you opt to do that, be sure the check goes directly from your company to the brokerage. If the check is made out to you, you could be liable for taxes and an early withdrawal IRS penalty. The brokerage will give you specific directions regarding how the check should be made out and where it should be sent.

SEP-IRA, or simplified employee pension, plans

These are company-sponsored IRAs that can be opened by the smallest of businesses, the sole proprietor. Under the SEP-IRA plan, an employer can contribute to his or her own retirement, or to an employee's existing IRA. In the case of an employee, the account is owned and controlled by the employee; the employer simply makes contributions to the financial institution where the account is held.

The penalties for early withdrawal remain the same as with the traditional IRA.

The employer receives the tax deduction for the contributions.

If you are a small-business owner, IRS publication 560, Retirement Plans for Small Business, explains the contribution limits for these plans.

SEP-IRAs give employers some flexibility. They don't have to contribute every year.

SIMPLE, or savings incentive match plans for employees, IRA

This is a company-sponsored plan that's designed for small businesses of 100 or fewer employees who make a minimum of $5,000 each. The plan can be set up at a designated financial institution or at an institution chosen by the employee.

A SIMPLE plan is a savings incentive match plan for employees in which the employer makes matching or nonelective contributions.


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