A Simple Explanation of an Individual Retirement Plan



An individual retirement plan is a tax-deferred account for people that are employed and their spouses. These types of accounts should not be confused with a 401k which goes through your employer. An individual retirement plan is a personal account that you will open through a bank, a brokerage firm, insurance company or a mutual fund. There are a wide range of options to choose from, and all of them will be untaxed until withdrawn upon.

Tax Law

On an individual retirement plan, the tax law lets you contribute up to $4,000 into your plan for the year 2005-2007 and up to $8,000 for married couples. However, married couples must file jointly on their tax return to qualify.

It’s important to remember that and individual retirement plan may be 100% tax deductible only if you are not covered by a work plan, such as a 401k. If covered by work, your plan may on be partially tax-deductible.

The Economic Growth and Tax Relief Reconciliation Act of 2001 allows individuals to increase their contributions in stages. This law also allows what is known as a “catch-up” contribution, but to qualify for this you must be 50 years of age or older. What this “catch-up” does is it allows you to put an extra $1,000 into your individual retirement plan each year.

The Stipulations

As with anything in life, there are stipulations, and your individual retirement plan is no different. Any money you withdraw is taxed at your ordinary tax rate and, if you withdraw before you reach the age of 59 1/2, it’s possible that there will be an extra 10% early withdraw tax.

Typically an individual retirement plan requires that you start to withdraw the money once you hit 70 1/2. On the good side, if you were not allowed to take what you contributed as a tax-deduction while you were working, then you don’t have to pay any taxes on it when you withdraw, but you will have to pay taxes on your interest.

The Roth individual retirement plan, however, lets you withdraw from you plan completely tax free after age 59 1/2, as long as the Roth plan as been active for at least 5 years. And the Roth plan does not require that you start withdrawing at the age of 70 1/2, instead, if you want, you can keep investing into the account as long as you have some type of earned income that you claim at the end of the year.

 


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