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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.
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until it's withdrawn, usually after age 59½. Money withdrawn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.
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