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What is an Individual Retirement Account (IRA)?

The individual retirement account is a personal, tax-deferred account for people who are employed, and their spouses. You can set up an IRA at almost any bank, brokerage, insurance company, or mutual fund. There are a wide variety of investment options to choose from, and your earnings are untaxed until they are paid out of the account.

Tax law lets you contribute up to $4,000 to your IRA for 2005-2007; $8,000 for married people who file a joint tax return. If you're not covered by a qualified retirement plan at work (or if covered, you fall below a certain income level) your IRA contribution may be fully or partially tax-deductible. The Economic Growth and Tax Relief Reconciliation Act of 2001 increased the IRA contribution limits, in stages. Click here for a chart of the annual contribution limits. The law also allows taxpayers age 50 and above to make an extra, "catch-up" contribution of $500 until 2006, at which point the catch-up contribution is $1,000. These figures are totals for all traditional and Roth IRA accounts combined. For 2008 and beyond, the IRA contribution limit will reach $5,000 ($6,000 if age 50 or over).

As with other tax-deferred plans, there are caveats. Any money you withdraw is taxed at your ordinary income tax rate. Plus, if you receive any withdrawals before you reach age 59 1/2, there may be a 10 percent penalty tax. Traditional IRAs require you to begin taking your money out once you attain age 70 1/2. One bonus: if you weren't permitted to take your IRA contributions as a tax deduction while you were working, you won't have to pay taxes on them when you take your money out (your accrued earnings will still be subject to taxes, however).

The Roth IRA is a variation that lets you withdraw principal and earnings completely tax-free after age 59 1/2, as long as the contributions have been in the plan at least five years. Unlike traditional IRAs, Roth IRAs don't require you to take distributions at age 70 1/2, and you can keep contributing to them as long as you like as long as you have earned income.

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What is an Individual Retirement Account (IRA)?

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