An Individual Retirement Account (hereafter called an IRA) is one of the biggest gifts that the government will ever give to you, so stop putting it off and accept Uncle Sam’s present to you. IRAs are a special type of account that allows you to save for your retirement with special tax privileges. Since the money that you deposit into an IRA account can be invested in many types of vehicles, the IRA is a great way to invest and save money on taxes at the same time.

In general, an IRA is an account that you may contribute a certain amount of money to per year, and then have that invested in any security, fund, bond, CD, or money market.

Are You Eligible?

There are two types of IRAs, traditional IRAs and Roth IRAs, which I will explain in detail later.

The only requirements for opening a traditional IRA are:

1) Have earned income
2) Under the age of 70 ½

The requirements for contributing to a Roth IRA are:

1) Have earned income
2) Have and Adjusted Gross Income (AGI) of less than $99,000 if single, $156,000 if married

Note: Between $99,000 and $114,000 the contribution levels are phased out, and a single tax filer is no longer eligible to contribute anything at $114,000. $156,000 to $166,000 for married couples.

Most likely you qualify for both a traditional IRA and Roth IRA, most people do. The real question is which IRA will make the most money, and sense, for you.

There are three different types of IRAs, and certain rules that you must abide by in order to fully utilize the tax benefits. But after reading this article you will be fully prepared to open an IRA of your own and maximize your benefits.

IRA Types

The contribution limits for traditional IRAs and Roth IRAs are the same and are listed below. If you have already reached the age of 50 by end of the tax year in which you opened your IRA account, you may add an additional $1000 catch-up contribution. It is also important to note that you can make contributions for the 2007 tax year up until April 15, 2008 (tax day). These contribution limits are assuming that your earned income is greater than these amounts. If you earned less than the contribution limit, you may only contribute up to the amount of your earned income.

IRA Contribution Limits

2007 $4000

2008 $5000

2009+ $5000

Traditional IRA

With a traditional IRA, contributions made during the year can be deducted from that year’s taxes. The amount of your contribution that is actually deductible depends on your adjusted gross income (AGI) listed on your 1040 form (for the 2007 1040 it was line 37). The deduction also depends on your “active participant status.” Basically, you are an active participant if you participate in your company’s retirement plan (401k, Simplified Employee Pension (SEP), profit-sharing plans, or other retirement plans). Use the table below to determine what type of deduction you can take for traditional IRA contributions in 2008.

2008 Traditional IRA Tax Deduction Table

With a traditional IRA, you may begin to take distributions at any time after the age of 59 ½. Distributions taken before this will result in penalties. You will also be required to receive a minimum distribution amount by April 1 after the year you turn 70 ½.

Distributions taken from a traditional IRA are treated as taxable income.

Roth IRA

Roth IRAs are tailored a little differently than traditional IRAs in that Roth IRA contributions are not tax deductible. This is not necessarily a negative, because with Roth IRAs, qualified distributions are completely tax free.

Qualified Distribution Rules

In order to take a qualified distribution from your Roth IRA, you must meet the following qualifications:

1. Have had the Roth IRA for 5 or more tax years

AND

1. You must be at least 59 ½ old, OR

2. You must be disabled (by the IRS definition), OR

3. You must use the distribution to pay for qualifying first time homebuying expenses, OR

4. The disbursement must be made to your beneficiary (or your estate) after your death

If the distribution does not meet these qualifications, it will be subject to taxes and possible penalties.

Roth IRAs are also a little more flexible than traditional IRAs because with a Roth IRA you can withdraw your contributions (but not earnings) at any time without tax or penalty. This flexibility makes the Roth IRA a good place to store and invest an emergency savings fund.

Traditional IRA versus Roth IRA Comparison

Here is a quick comparison of the advantages and disadvantages of both the traditional IRA and Roth IRA.

The main difference between the two is the tax differences. If you need the tax deduction now, and expect to have a lower tax liability in your retirement, choose the traditional IRA.

If you would rather take your IRA distributions tax free in retirement, or you would like the flexibility of being able to withdraw contributions at any time, then choose the Roth IRA.

How to Open Your Own IRA

Many banks, credit unions, brokers, and other financial institutions offer IRA accounts, but I recommend using a discount broker. Many of the institutions charge an annual fee for maintaining your IRA, but many discount brokers do not.

Since IRAs can be invested in stocks and funds as well as bonds, CDs and money markets, you should also consider the commission that the institution charges for transactions as this will eat into your earnings.

IRAs in general are a great way to save for retirement because your money will grow tax deferred. Roth IRAs are also a great place to store and invest your emergency savings fund because you can withdraw contributions at any time. Now that you are well informed, don’t waste another day of tax deferred earnings opportunity and open your own traditional or Roth IRA today!