Created under federal tax law, an individual retirement account (IRA) is a tax-deferred retirement program in which any employed person can participate. The extent of annual contributions and the tax deductibility thereof are, however, dependent on the individual worker's situation.

IRAs were authorized by Congress in 1974 as part of a broader effort to reform laws governing pensions. Subsequent legislation, in particular the Tax Reform Act of 1986, has refined the scope, provisions, and requirements of IRAs so that currently not only the basic, individual "contributory" IRA but also other forms of the plan are available. As outlined by W. Kent Moore in The Guide to Tax-Saving Investing, these include: spousal IRAs, enabling a working spouse to contribute to an IRA opened for a nonworking partner; third-party-sponsored IRAs, used by employee organizations, unions, and others wishing to contribute on workers' behalf; simplified employee pensions (SEPs), enabling employers to provide retirement benefits by contributing to workers' IRAs; and so-called rollover contributions, allowing distributions from an IRA or an employer's qualified plan to be reinvested in another IRA.

While the rules and regulations are quite specific, employees using the basic contributory IRA can generally contribute up to $2,000 per year until they reach the age of 70 1/2. Whether or not these contributions are tax deductible depends on the worker's income level and eligibility for an employee pension plan; nevertheless, the dividends and interest earned by the investment accumulate in the account on a tax-free basis. Typically, IRA funds are invested in varied ways, including stocks and bonds, money market accounts, treasury bills, mutual funds, and certificates of deposit.

The Small Business Job Protection Act of 1996 (SBJA) and the Taxpayer Relief Act of 1997 (TRA) liberalized many of the rules governing IRAs, and, in general, made IRAs more attractive investments than ever before. Under the SBJA, spouses filing jointly were able to contribute up to $4,000 per year, even if one spouse had no earnings for the year. The TRA removed penalties for premature withdrawal of IRA funds in cases of medical or dental expense or unemployment, and enabled self-employed individuals to deduct their health-insurance costs. It also created two new types of IRA: the Roth IRA, contributions to which are taxable, but can be made after the owner reaches the age of 70 1/2, and is not taxed upon withdrawal; and the Education IRA, into which contributors can place a nondeductible total of $500 per child per year to defray future educational expenses.

Those interested in opening an IRA should familiarize themselves with the regulations governing the amounts that may be contributed, the timing of contributions, the criteria for tax deductibility, and the penalties for making early withdrawals. They should also shop around when investigating financial institutions that offer IRAs, in as much as fees vary from institution to institution, ranging from no charge to a onetime fee for opening the account to an annual fee for maintaining the IRA. Still, as Moore noted, "The advantages of IRAs far outweigh the disadvantages.… Earnings for either deductible or nondeductible IRAs grow faster than ordinary savings accounts, because IRA earnings are tax deferred, allowing all earnings to be reinvested. Even when withdrawals are made, the remaining funds continue to grow as taxdeferred assets."

[ Roberta H. Winston ,

updated by Grant Eldridge ]


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