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. Here are 10 must-know IRA terms.
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 SEPs and SIMPLE IRAs.2. Individual retirement account, or IRA
IRAs are retirement accounts with tax advantages. You may contribute up to $5,000 in 2008. Or, if you're 50 or older, you can put aside up to $6,000 for that tax year. But your contributions can't exceed your earned income. The investment grows tax-free until you begin making withdrawals, usually after age 59½. Take money out before then and you will usually get hit with a 10 percent penalty unless you meet certain specified requirements.3. Contribution
IRA contributions are limited to $5,000 for the 2009 tax year if you're younger than 50. If you're 50 or older, you can contribute as much as $6,000 for the 2009 tax year. The limits are the same for 2010. Contributions are classified as either tax deductible or nondeductible.4. 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.5. Modified adjusted gross income, or MAGI
For the purpose of determining your contribution limit, some people use their MAGI. For most people, this will be the line on your taxes that says "adjusted gross income," or AGI, but some taxpayers will have to modify their AGI by adding back some income or tax breaks. These add-backs range from foreign income you didn't have to count in your adjusted gross income to interest income for Series EE bonds that you used to pay for qualified educational expenses to a deduction for student loan interest or a traditional IRA contribution.
6. Required minimum distribution
Generally, if you have a traditional IRA, you must begin taking money out of the account by April 1 of the year after you turn 70½. The amount is a minimum distribution determined by your age and life expectancy. The IRS has established simplified tables that a traditional IRA owner can use to determine 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.