retirement

10 must-know IRA terms

Computer keyboard keys with word IRA © karen roach/Shutterstock.com

© karen roach/Shutterstock.com

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 taxable 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 traditional IRA, moving expenses, alimony and capital losses, interest penalty on early withdrawal of bank CDs 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. There are 2 types of IRAs: a traditional IRA, which, for some people, provides a tax deduction, and a Roth IRA (more on this account later). Regardless of the type of IRA, your investment grows tax-free until you begin making withdrawals, usually after age 59 1/2. If you take out money before then, you could be hit with a 10% penalty unless you meet certain specific requirements.

3. Retirement plan contribution

You must earn money through work to make retirement plan contributions. If you have a traditional IRA, you can't contribute to that account once you reach the year you will turn 70 1/2. However, you can put money in a Roth IRA as long as you earn income, regardless of your age. Age 50 also is a key birthday. Once you celebrate this milestone, you can make additional catch-up contributions to any type of IRA.

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 70 1/2. 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 minimum 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.

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