Retirement and Taxes: Understanding IRAs
Individual retirement arrangements, or IRAs, provide tax incentives for investments that most employees can use to provide for their financial security in retirement. Accounts can be set up with banks or other financial institutions, such as life insurance companies, mutual fund firms or stock brokerages.
IRAs are funded through employee contributions. Annual limits that are placed on contributions vary based on your age and the type of IRA you have. Generally, you need to have earned income to contribute to an IRA. Earned income includes wages, salaries, commissions, tips, bonuses and net income from self-employment, but not earnings and profits from property, your pension or annuity income. Some alimony and maintenance payments, money received for graduate and postdoctoral studies, and difficulty-of-care payments may be treated as compensation for purposes of contributing to an IRA.
You can start taking money out of an IRA without a penalty when you get to age 59 1/2. If you attempt to withdraw funds before then, you face a 10% penalty and a tax bill unless you qualify for an exception. At the other end, when you hit age 70 1/2, you must begin to withdraw funds from your account. If your 70th birthday is on or after July 1, 2019, withdrawals aren't due until age 72.
Several flavors of IRAs
There are different kinds of IRAs, each with its own rules:
Inheriting an IRA
There are several tax scenarios you may face if you inherit an IRA. It depends on what kind of IRA you inherit and on your relationship to the deceased.
If a traditional IRA is inherited from a spouse, the surviving spouse generally has the following three choices. He or she can:
If the inherited traditional IRA is from anyone other than a deceased spouse, the beneficiary cannot treat it as his or her own. This means that the beneficiary cannot make any contributions to the IRA or roll over any amounts into or out of the inherited IRA. The heir will need to make required distributions even before reaching the retirement age.
If it is a Roth IRA, generally, the entire interest must be distributed by the end of the fifth calendar year after the year of the owner's death unless the interest is payable to a designated beneficiary over the life or life expectancy of the designated beneficiary. If the sole beneficiary is the spouse, he or she can either delay distributions until the decedent would have reached age 70 1/2 or treat the Roth IRA as his or her own.
This is just a brief summary of lengthy rules. There are more provisions and exceptions. If you have an IRA or are thinking of starting one, work with a qualified financial professional.
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