If you have or are thinking of establishing an IRA, give yourself a pat on the back. A great resource for retirement, an IRA allows you to enjoy the benefits of compounding growth and tax savings. But the language of finance sometimes makes simple concepts seem more complicated.
Learn the language
Here's the plain-English guide to some of the terms you'll likely encounter as you set up and manage your account.
1. Adjusted gross income, or AGI -- Used to calculate federal income tax, your 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, interest penalty on early withdrawal of bank CD certificates and payments made to retirement plans such as SEP and SIMPLE IRAs.
2. Contribution -- IRA contributions are limited to $5,000 for the 2008 tax year if you're younger than 50. If you're 50 or older, you can contribute as much as $6,000 for the 2008 tax year. The limits are the same for 2009. Contributions are classified as either tax deductible or nondeductible.
3. Deductible or 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 on your income and filing status. Contributions to a Roth IRA are not deductible.
4. Education IRA -- Renamed Coverdell education savings account, in honor of the late Sen. Paul Coverdell, this is not strictly an IRA, since it doesn't finance retirement. Instead, you can make annual contributions, of up to $2,000 per child, to an account that's exclusively for helping to pay education costs. The money you put aside in a Coverdell account doesn't count against the annual retirement IRA contribution limits for you or your child. You can't deduct the Coverdell contributions from your income taxes, but earnings are tax-deferred and qualified withdrawals are tax-free.