What Is an IRA (Individual Retirement Account)? – Introduction, Contribution Limits, Early Withdrawal Penalties, Advantages/Disadvantages

Also known as an Individual Retirement Arrangement, an IRA is a retirement savings plan available to anyone who receives taxable employment income or compensation in a given year. Examples of taxable income include wages, salaries, bonuses, taxable alimony, commissions, fees & tips. An individual can have multiple IRA accounts but the total contribution limits are outlined in the table below.
Note: An individual’s IRA contribution is limited to the lesser of total taxable compensation, or the normal annual contribution limits, whichever is lower.

Year Regular Contributions Catch Up Contributions
2001 $2000 $0
2002 $3000 $500
2003 $3000 $500
2004 $3000 $500
2005 $4000 $500
2006 $4000 $1000
2007 $4000 $1000
2010 $5000 $1000
2009 $5500 $1000

Beginning in 2009, annual IRA contribution limits will increase by $500 adjusted for inflation. All contributions to an IRA are tax-free until withdrawn at the age of 59 and 1/2. Any withdrawals made prior to that are subject to a 10% early withdrawal penalty as well as income taxes owing. There are 8 exceptions to this, see the 8 exceptions below.

Traditional IRA contributions may or may not be tax deductible depending on the tax filing status of the investor. This also depends on the adjusted gross income (AGI) and eligibility to participate in a qualifed IRA retirement plan. Deductibility of contributions becomes zero if the IRA investor’s income falls in between these adjusted gross incomes (AGIs).

Year Filing as Single Filing as Joint
2001 $33,000 – $43,000 $53,000 – $63,000
2002 $34,000 – $44,000 $54,000 – $64,000
2003 $40,000 – $50,000 $60,000 – $70,000
2004 $45,000 – $55,000 $65,000 – $75,000
2005 $50,000 – $60,000 $70,000 – $80,000
2006 $50,000 – $60,000 $75,000 – $85,000
2007 $50,000 – $60,000 $80,000 – $100,000

A working spouse who is not enrolled in employer sponsored IRA can make a tax-deductible contribution of a maximum of $2000 to an IRA each year, even if the other spouse is enrolled in an employer sponsored IRA. When the couple’s combined adjusted gross income reaches $150,000, tax deductibility for such contributions lowers. At an AGI of $160,000, it becomes $0!

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