Individual Retirement Accounts

There have been many changes and additions to Individual Retirement Accounts (IRAs) since they were first introduced in the Seventies, but the basic idea remains the same: to help you reduce or avoid taxes while you save for retirement or another long-term goal.

The Traditional IRA was first developed to help supplement company pension and retirement plans. Your contributions may be fully deductible, partially deductible or not deductible, depending upon your income and other retirement coverage.

Dividends are not taxed until you begin withdrawing funds at retirement, when you will presumably be in a lower tax bracket. You can begin withdrawing funds without penalty when you reach age 59 1/2. If you take out money before then, you usually will face a 10 percent penalty, plus taxes on the withdrawn amount. When you turn 70 1/2 you can no longer make contributions to your account, and must start withdrawing money from the account or face additional penalties.

Roth IRAs have no immediate tax deduction. Since contributions are made with money that has already been taxed, there is no immediate tax break. But when money is taken out, it is a tax-free distribution. This makes Roth IRAs ideal for individuals who are in a lower tax bracket now, but anticipate being in a higher tax bracket at retirement.

Again, the allowable contribution amounts depend on your tax-filing status and adjusted gross income, and once you exceed certain limits you can’t put any money into a Roth IRA. You may make contributions at any age, even after you reach 70 1/2, but you must have your Roth account for at least five years before you can take a penalty free distribution of earnings.

Coverdel Education Savings Accounts or ESAs (formerly known as Education IRAs) are used exclusively to help to pay higher education costs. Individuals can make annual contributions of up to $2,000 per child, and money contributed to a ESA doesn’t count against the annual totals that determine how much individuals may contribute to their personal, individual IRAs. The earnings and withdrawals from a ESA are tax-free, but you can't deduct the contributions from your income tax because the account is for the benefit of the child, not the contributor.

To learn more about these products, visit CMECU's IRA Center.