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What is an IRA?

An Individual Retirement Account (IRA) is a type of savings account that provides certain tax benefits. Saving for retirement with tax-free growth or on a tax-deferred basis has many advantages.

If you haven't already included an Individual Retirement Account in your retirement savings plan, you could be missing a great opportunity to save for your retirement dreams and reduce your tax bill.

There are different types of IRAs, each with their own unique set of tax implications and eligibility requirements.

Traditional IRA

  • A traditional IRA is considered a tax-deferred retirement savings vehicle. This means that you will not have to pay any taxes on your earnings from this account until you withdraw the funds. As a result, you may be able to accumulate more in an IRA compared to taxable accounts because you are able to defer taxes on the interest and dividends earned by your IRA’s investments

  • Your contribution may be tax deductible if you meet certain criteria. The restrictions on who can take a deduction for Traditional IRA contributions are based on both your income and whether you or your spouse are covered by a retirement plan at work.

  • When you withdraw the money from the IRA, the distribution is included in your taxable income. It is taxed as ordinary income.

  • In general, IRAs should not be accessed prior to retirement. If you withdraw the money before reaching age 59 and a half, there is an additional 10 percent tax on that early distribution. The penalty tax is in addition to federal and state income taxes at your ordinary income tax rate. Some exceptions to the early withdrawal rules exist allowing you to take money from your IRA without penalty if you meet certain criteria.

  • It is important to note that an IRA is not an actual investment, but rather a type of an account that may be funded with investments such as stocks, bonds, mutual funds, CDs, or other allowable investments.

With a traditional IRA you must take minimum distributions no later than the year when you turn 72 years old. If you do not meet the required minimum distribution each year you will have to pay an excise tax of 50 percent of the required minimum distribution amount.

Roth IRA

IRA Contribution Limits

The total amount that can be contributed to a Traditional IRA and/or a Roth IRA is limited.

  • The maximum annual contribution for 2020 is the lesser of $6,000 or 100 percent of earned income.

  • Taxpayers age 50 and older can contribute another $1,000 for a total contribution of $7,000.

You may contribute to both types of accounts if you do not exceed the annual contribution limits. For example, you could potentially put $3,000 in a Traditional IRA and $3,000 in a Roth IRA, or split your contributions in any other manner, as long as you don’t exceed the annual limit of $6,000.

IRA contributions are also limited by your qualifying income. For the purposes of determining your eligibility to make an IRA contribution, qualifying income means wages self-employment , alimony, and non-taxable combat pay. Therefore, if you have $4,500 in earned income that amount will become your contribution limit. This rule is especially important for parents seeking to make IRA contributions on behalf of their children who may have limited income from part-time work.

The other income limitation is that you won't be able to contribute to a Roth IRA or take a deduction for contributions to a Traditional IRA if you earn too much. The IRS website shows income limits for contributing to Roth and Traditional IRA’s. ​


  • A Roth IRA is a non-deductible retirement savings vehicle.

  • Unlike a Traditional IRA, where the account grows on a tax deferred basis, A Roth IRA provides potentially tax-free growth of retirement savings and distributions. Distributions from a Roth IRA are completely tax-free, as long as you meet certain conditions. As a result, you may be able to accumulate more in your Roth IRA than in a taxable account because you are not paying tax every year on the interest and dividends earned in your Roth IRA account.

  • You can potentially make contributions to a Roth IRA even if you are covered by a retirement plan at work.

  • The ability to contribute directly to Roth IRAs is based on income limitations.

  • Unlike Traditional IRAs, Roth IRAs are not subject to required minimum distribution rules throughout your lifetime.

  • Like a Traditional IRA, it is once again important to note that a Roth IRA is not an actual investment. Instead, it is a type of account that may be funded with stocks, mutual funds, CDs, or other suitable investments.


Deadlines to Contribute to an IRA

IRA contributions can be made at any time throughout the year. They are not limited by the calendar year, but must be made by tax day to count toward your contribution limit for the prior year. As a result, you can make a 2020 IRA contribution as late as April 15, 2021. ​


Individual Retirement Accounts for Small Business Owners and the Self-Employed

While self-employment has many advantages, it can be a challenge to save enough for retirement. If you work as an independent contractor, have any self-employment income, or run a small business you may be eligible for other types of Individual Retirement Accounts. The Simplified Employee Pension, more commonly known as a SEP-IRA, and the SIMPLE IRA are the other types of IRAs to pay attention to if you are your own boss (even if it’s only a part-time gig).

Simplified Employee Pension (SEP-IRA):

A SEP IRA is a retirement plan that an employer or self-employed individuals can establish. The employer receives a tax deduction for contributions made to the SEP plan and makes contributions to each eligible employee's SEP IRA on a discretionary basis. The key advantage of the SEP-IRA is the lesser of 25% of employees compensation or $57,000 in 2020 is much higher than the $6,000 cap associated with a Traditional or Roth IRA.

Savings Incentive Match Plan for Employees (SIMPLE IRA):

A SIMPLE IRA is an employer-sponsored retirement plan offered within small businesses that have 100 or less employees. Small businesses may favor SIMPLE IRAs because they are a less expensive and less complicated alternative to a  401K plan. These plans have specific rules on employer matching incentives which are built into the plan. In 2020, employees can generally contribute $13,500 to a SIMPLE IRA. The catch up contribution limit for 2020 is $3,000 making the SIMPLE IRA contribution limit $16,500 for participants age 50 or older.

Inherited IRA

Individual Retirement Accounts (IRAs) have become a popular retirement savings vehicle for generations of investors. A new generation of IRA investors is emerging—one that has inherited, or will inherit an IRA from a parent, spouse or other person. When you open an IRA you generally name a beneficiary. This could be a spouse, children or other individuals, a trust or charity, or some combination. For inheritance purposes, the named IRA beneficiary takes precedent over a will or trust.


When a Spouse Inherits

In many cases, it is the surviving spouse who is the named beneficiary and inherits an IRA. If that is your situation, you have a number of options:

  • Treat the inherited IRA as yours by designating yourself as the account holder. In short, you create a new IRA in your name. The IRA (traditional or Roth) becomes yours, and RMDs are determined as if you were the owner beginning with the year you elect or are deemed to be the owner.

  • Treat the inherited IRA as yours by rolling it into a traditional IRA you already hold or into a qualified employer plan such as a 401(k) or 403(b) set up in your name. The assets are then treated as your own.

  • Treat yourself as the beneficiary (as opposed to becoming the account holder). In essence, you create an "inherited IRA," into which the assets of the original IRA are transferred. Depending on the age of the original account owner upon death, you can elect to take distributions over your own or the original account owner's life expectancy, sometimes referred to as the "life expectancy method," or over a ten-year period.

  • Take a lump-sum distribution.

    • You may incur taxes on the distribution for a traditional IRA.

    • For a Roth, only earnings are taxable if the account is less than five years old at the time of the account-holder's death.

    • You will not incur a 10 percent early withdrawal penalty even if you are under age 59½.

When a Non-Spouse Inherits

If the inherited IRA is from anyone other than a deceased spouse, you have fewer options.

  • Transfer the assets into an inherited IRA in your name. Non-spouse beneficiaries cannot treat an inherited IRA as his or her own (as spouses can). As such, they can't make any new contributions to the IRA or roll over any amounts into or out of the inherited IRA. The IRS does, however, allow for moving the IRA to another firm via a trustee-to-trustee transfer that meet certain conditions.

    • Inherited Retirement Accounts: Upon death of the account owner, distributions to individual beneficiaries must be made within 10 years. There are exceptions for spouces, disabled individuals and individuals not more than 10 years younger than the account owner. Minor children who are beneficiaries of IRA accounts also have a special exception to the 10-year rule, but only until they reach the age of majority.

  • Take a lump-sum distribution (same as spouse option).

    • You may incur taxes on the distribution for a traditional IRA.

    • For a Roth, only earnings are taxable if the account is less than five years old at the time of the account -holder's death.

    • You will not incur a 10 percent early withdrawal penalty even if you are under age 59 ½.