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What Is An IRA?

What is an IRA?

Most people know that an IRA is an “Individual Retirement Account”. IRAs were first established in 1974. The first type of IRA was the Traditional IRA. In 1978 we saw the advent of the Simplified Employee Pension Plan (SEP) & 401(k)s. In 1978 the Roth IRA arrived. Today, we also have the Solo-k and other variations each with their own benefits.

Is an IRA a trust?

The IRS’ definition: an IRA is a trust created in the United States for the exclusive benefit of an individual or his beneficiaries. As with any trust, there must be a trustor, a trustee, a trust beneficiary and trust assets.

What types of IRAs are available?

Traditional IRA

The Traditional Individual Retirement Account is the most common type of IRA. This IRA was created for individuals that do not participate in an employer sponsored retirement plan. However, certain individuals that do participate in an employer sponsored retirement program may still qualify for this IRA. Unlike the Roth IRA, the only criteria for being eligible to contribute to a Traditional IRA is sufficient income to make the contribution. However, the best provision of a Traditional IRA—the tax-deductibility of contributions—has strict eligibility requirements based on income, filing status, and availability of other retirement plans (mandated by the Internal Revenue Service). Transactions in the account, including interest, dividends, and capital gains, are not subject to tax while still in the account, but upon withdrawal (or distribution) the funds are taxed as ordinary income.


A SEP IRA provides more opportunity. Simplified Employee Pension plans are company-sponsored IRAs that can be opened by small businesses and sole proprietors. The IRS characterizes the sole proprietor as the employee in the SEP plan.

The IRS says an individual is able to contribute a portion of his net earnings. There are no real administration costs if you are self-employed and don’t have any employees. Net earnings are measured as gross income less any deductible business expenses. The deduction includes your own SEP IRA contribution. The IRS provides a worksheet to assist in the correct calculation.

The Maximum contribution is 25% of net earnings up to a limit of $46,000 (2008) and $49,000 for 2009. When: A SEP IRA needs to be established & contribution needs to be completed by the time that you file your taxes (including extensions). For most people that filing date is April 15th. How: You must fill out paperwork with a bank or brokerage or create an account with an independent custodian. The IRS has a model SEP plan document, Form 5305-SEP, Simplified Employee Pension – Individual Retirement Accounts Contribution Agreement. This form is not filed with the IRS Why: This plan is easy to create and administer since you do not have to file any yearly reports with the IRS. Any Investment earnings grow tax-deferred until distribution. There are no complicated forms to fill out and no annual reports required by the IRS.

SIMPLE (Savings Incentive Match Plan for Employees) IRA

This is a type of Individual Retirement Account that is set up to be an employer-provided plan. It is a qualified plan like more well-known plans such as the 401(k) Profit-Sharing plan and 403(b) Tax Sheltered Annuity plan, but offers simpler and less costly administration rules. Like the 401(k), the SIMPLE IRA is funded by a pre-tax salary contribution. Contribution limits for SIMPLE plans are lower than for most other types of employer-provided retirement plans.

Education IRA

An education IRA is a custodial account or trust, usually maintained by a bank or financial organization, exclusively for the purpose of paying the qualified higher-education expenses of the designated beneficiary. Education IRAs must accept contributions only in cash, and cannot accept contributions for a beneficiary after he or she turns 18. In addition, the education IRA cannot accept contributions of more than $500 (except for rollover contributions) for any single year.

Solo 401(k)

The “Solo K” allows a self employed individual or married couple to make an annual contribution of up to $98,000 per year for retirement (as much as $40k of qualifying after-tax “Roth” contribution provided the beneficiaries are over 50 years old).

The Solo Roth 401(k) enables beneficiaries the ability to take advantage of several opportunities that were previously forbidden. The Solo K additionally allows one to invest in two types of investments previously unattainable for a retirement account; “S” corporation stock and life insurance. It is even possible for the beneficiary to borrow up to $50k or 50%(whichever is less) from your Solo K.

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