Retirement Plans – Individual Retirement Accounts (IRAs)
For decades, IRAs have been among the most popular ways to put away money for retirement while getting a current tax deduction. You also don’t have to pay any current income taxes on any money the account earns— until you start taking distributions, that is, and then you get taxed on every dollar you take out. A new twist was added with the arrival of the Roth IRA; this version gives you no tax deduction on contributions now in exchange for no taxes at all on the earnings (when you wait at least ﬁve years to take a qualiﬁed distribution). Both traditional and Roth IRAs continue to grow in popularity as more people get cracking on their retirement savings.
Many of the most popular small-business retirement plans are based on the IRA. In fact, some of them (such as the SEP and some SIMPLEs) are really just a collection of IRAs brought together under the umbrella of the company’s general retirement plan.
As a business owner, you do have other options when it comes to put- ting away money for the future, but none is as simple as an IRA—regardless of their catchy acronyms (you’ll read more about these later in this chapter). If you want to save money for yourself without the hassle of a formal retirement plan and without having to make contributions for your employees, you can just open a personal IRA.
All you have to do to open an IRA is ﬁll out a single form and send in a check. You can do it at your bank, do it with your broker, or even do it online with an electronic bank transfer. It can be a standard interest-bearing savings account, or you can ﬁll it with stocks, bonds, and mutual funds. Multiple IRAs are also possible; for example, you might do that when you want to invest directly in mutual funds (as opposed to going through a broker and paying his fees) but want funds from different fund families.
The Common Rules
Here are the basic rules for both kinds of IRAs. You can’t contribute more than your taxable income; for example, if your sole proprietorship earns $2,000 this year, that’s the most you can put into an IRA (unless you have other income, such as a salary). For 2006 and 2007, the maximum contribution is $4,000 per person (no matter how many IRAs you have), but if you’re 50 or older, you can bump that up by another $1,000. In 2008, that max jumps to $5,000 for everyone, and the $1,000 add-on can still be used for anyone who’s at least 50 years old. Contributions have to be made with money; you can do it by credit card, but you can’t do it with a diamond necklace. You have to make the contribution by the time you ﬁle your tax return in order for it to count in that tax year; for example, if you make a $4,000 contribution on April 15, 2007, when you ﬁle your 2006 tax return, the IRA deduction counts for 2006. Other than these rules, the two types of IRAs don’t have much in common.
More Rules for Traditional IRAs
In addition to the tax differences mentioned earlier, the two IRA types veer onto different paths in other ways:
- You have to start taking distributions from a traditional IRA the year after you hit age 70 1/2 or the year you retire, whichever comes last; there are no mandatory distribution requirements with Roth IRAs.
- Once you hit age 70 1/2, you can’t make any more contributions, even during that year; there’s no age limit on contributions into a Roth IRA.
- There are many restrictions on when and how you can take money out of your traditional IRA, and restricted distributions can be subject to hefty penalties; with Roth IRAs, once the cash has been sitting there for ﬁve years and you hit age 59 1/2 you can do whatever you want with it.
For the speciﬁc rules that apply to your unique situation, talk to your accountant or IRA plan manager before you take out any money, especially if you have a traditional IRA. Mistakes can lead to IRS penalties, and those can be pretty big.