Basic Information Individual Retirement Accounts

An individual retirement account, commonly known as an IRA or traditional IRA, is a retirement plan that allows the account holder to make pre-tax contributions to save for future use. Individual retirement accounts are created through a financial institution such as a bank or a brokerage firm which allow the account holder to deposit funds from wages earned before taxes. The money deposited can accrue interest if place in certificates of deposit from banks or in mutual funds through a brokerage firm.

Individual retirement accounts were first made available in 1975, but were officially noted under the Tax Reform Act of 1986 (TRA) as a part of the Internal Revenue Code. As such, the Internal Revenue Services (IRS) defines an IRA as a qualified retirement plan.

Traditional individual retirement accounts also allow the account holder to receive certain tax deductions only if they qualify under guidelines set by the IRS. These guidelines include having income, tax filing status, and being able to invest in other qualified retirement plans. The funds placed in an individual retirement account are not taxable under federal income taxes as the funds are deposited on a pre-tax basis. This means that contributions are made before the account holder receives wages and uses them, thus deducting them from the account holder's annual income.

The IRS also places additional restrictions on individual retirement accounts in regard to withdrawals, also known as distributions, and contributions. The IRS penalizes any withdrawals made from an individual retirement account prior to the age of 59.5 by taxing those monies under federal income taxes just as with a 401(k) plan. This is because those funds are being used for purposes other than retirement and have been returned to the account holder's annual income.

Additionally, funds in an individual retirement account must be distributed prior to the account holder reaching the age of 70.5. This allows the account holder to continue to accrue interest for a period of time after reaching full retirement age. The IRS also places annual restrictions how much money can be contributed to an IRA. This means that the account holder can make contributions up to the maximum amount as set by the IRS. If the contributions exceed that amount, the excess must be withdrawn prior to April 15th of the next tax year.