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Retirement and taxes: Understanding IRAs

Individual Retirement Arrangements, or IRAs, provide tax incentives for people to make investments that can provide financial security for their retirement. These accounts can be set up with a bank or other financial institution, a life insurance company, mutual fund or stockbroker.

The IRS has put together a basic overview to help people better understand this type of retirement savings account.

  • Contribution. The money that someone puts into their IRA. There are annual limits to contributions depending on their age and the type of IRA. Generally, a taxpayer or their spouse must have earned income to contribute to an IRA.
  • Distribution. The amount that someone withdraws from their IRA.
  • Withdraws. Taxpayers may face a 10% penalty and a tax bill if they withdraw money before age 59 ½, unless they qualify for an exception.  
  • Required distribution. There are requirements for withdrawing from an IRA:
    • Someone generally must start taking withdrawals from their IRA when they reach age 70½.
    • Per the 2019 SECURE Act, if a person’s 70th birthday is on or after July 1, 2019, they do not have to take withdrawals until age 72.
    • Special distribution rules apply for IRS beneficiaries.
  • Traditional IRA. An IRA where contributions may be tax-deductible. Generally, the amounts in a traditional IRA are not taxed until they are withdrawn.  
  • Roth IRA. This type of IRA that is subject to the same rules as a traditional IRA but with certain exceptions:
    • A taxpayer cannot deduct contributions to a Roth IRA.
    • Qualified distributions are tax-free.
    • Roth IRAs do not require withdrawals until after the death of the owner.
  • Savings Incentive Match Plan for Employees. This is commonly known as a SIMPLE IRA. Employees and employers may contribute to traditional IRAs set up for employees. It may work well as a start-up retirement savings plan for small employers.  
  • Simplified Employee Pension. This is known as a SEP-IRA. An employer can make contributions toward their own retirement and their employees’ retirement. The employee owns and controls a SEP.  
  • Rollover IRA. This is when the IRA owner receives a payment from their retirement plan and deposits it into a different IRA within 60 days.

For more information on how an IRA might impact your unique tax situation, contact our office.

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