Retirement and taxes: Understanding IRAs

Individual Retirement Arrangements, or IRAs, provide tax incentives for people to make investments that can provide financial security for their retirement. These accounts can be set up with a bank or other financial institution, a life insurance company, mutual fund or stockbroker.

Here's basic overview to help people better understand this type of retirement savings account.

• Contribution. The money that someone puts into their IRA. There are annual limits to contributions depending on their age and the type of IRA. Generally, a taxpayer or their spouse must have earned income to contribute to an IRA.

• Distribution. The amount that someone withdraws from their IRA.

• Withdraws. Taxpayers may face a 10% penalty and a tax bill if they withdraw money before age 59 ½, unless they qualify for an exception.

• Required distribution. There are requirements for withdrawing from an IRA:

  • Someone generally must start taking withdrawals from their IRA when they reach age 70½.

  • Per the 2019 SECURE Act, if a person's 70th birthday is on or after July 1, 2019, they do not have to take withdrawals until age 72.

  • Special distribution rules apply for IRA beneficiaries.

• Traditional IRA. An IRA where contributions may be tax-deductible. Generally, the amounts in a traditional IRA are not taxed until they are withdrawn.

• Roth IRA. This type of IRA that is subject to the same rules as a traditional IRA but with certain exceptions:

  • A taxpayer cannot deduct contributions to a Roth IRA.

  • Qualified distributions are tax-free.

  • Roth IRAs do not require withdrawals until after the death of the owner.

• Savings Incentive Match Plan for Employees. This is commonly known as a SIMPLE IRA. Employees and employers may contribute to traditional IRAs set up for employees. It may work well as a start-up retirement savings plan for small employers.

• Simplified Employee Pension. This is known as a SEP-IRA. An employer can make contributions toward their own retirement and their employees' retirement. The employee owns and controls a SEP.

• Rollover IRA. This is when the IRA owner receives a payment from their retirement plan and deposits it into a different IRA within 60 days.