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:

  • Traditional IRA — In this type of plan, you deposit pretax dollars, and the money isn’t taxed until it’s withdrawn.
  • Roth IRA — In this type of plan, you deposit after-tax money, so qualified distributions are tax free. Withdrawals aren’t required until after the death of the owner.
  • Savings Incentive Match Plan for Employees IRA — The SIMPLE IRA works well as a start-up retirement savings plan for small businesses, especially sole proprietorships. It is available to any small business, which generally means any business with 100 or fewer employees.
  • Rollover IRA — This term doesn’t refer to a tax status, but you may hear it when IRAs are mentioned. If you take distributions from any type of retirement plan and deposit them directly into an IRA within 60 days or have the other plan’s administrator deposit the funds directly, then the second plan is called a rollover IRA.

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:

  • Treat it as his or her own IRA by designating himself or herself as the account owner.
  • Treat it as his or her own by rolling it over into a traditional IRA or rolling it over to the extent it is taxable into one of several other kinds of plans.
  • Treat himself or herself as the beneficiary rather than treating the IRA as his or her own.

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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