Individual Retirement Accounts (IRAs) are some of the most popular retirement plans available to supplement your retirement years with additional funding. IRAs are investing tools which can encompass a range of financial products, including stocks, bonds, ETFs, and mutual funds.

Unlike other retirement products, anyone can have one or more IRAs in addition to any other type of retirement account. You can open different kinds of IRAs with a variety of organizations. You can open an IRA at a bank or other financial institution or with a mutual fund or life insurance company or your stockbroker. Any IRA must meet Internal Revenue Code requirements.

There are several types of IRAs: the traditional IRA, the Roth IRA, SEP, and SIMPLE IRA. Individual taxpayers establish traditional and Roth IRAs, while small-business owners and self-employed individuals establish SEP and SIMPLE IRAs.

The Traditional IRA

The IRS states that a traditional IRA is any IRA that isn't a Roth IRA or a SIMPLE IRA [sic]. Sometimes referred to as the original IRA, an ordinary or regular IRA, a traditional IRA has two main advantages:

• You may be able to deduct some or all of your contributions to it, depending on your circumstances; and
  
  
• Generally, amounts in your IRA, including earnings and gains, aren't taxed until they are distributed.

Generally, compensation is what you earn from working. Compensation includes wages, salaries, tips, professional fees, bonuses, and other amounts you receive for providing personal services. Compensation also includes commissions and taxable alimony and separate maintenance payments.

An amount you receive that is a percentage of profits or sales price is compensation.

If you are self-employed (a sole proprietor or a partner), compensation is the net earnings from your trade or business (provided your personal services are a material income-producing factor) reduced by the total of:

• The deduction for contributions made on your behalf to retirement plans, and
  
  
• The deductible part of your self-employment tax.

An individual retirement account is a trust or custodial account set up in the United States for the exclusive benefit of you or your beneficiaries. The account is created by a written document that must show that the account meets all of the following requirements.

• The trustee or custodian must be a bank, a federally insured credit union, a savings and loan association, or an entity approved by the IRS to act as trustee or custodian.
  
  
• The trustee or custodian generally can’t accept contributions of more than the deductible amount for the year. However, rollover contributions and employer contributions to a SEP can be more than this amount.
  
  
• Contributions, except for rollover contributions, must be in cash.
  
  
• You must have a nonforfeitable right to the amount at all times.
  
  
• Money in your account can’t be used to buy a life insurance policy.
  
  
• Assets in your account can’t be combined with other property, except in a common trust fund or common investment fund.
  
  
• You must start receiving distributions by April 1 of the year following the year in which you reach age 701⁄2.

You can open an individual retirement annuity by purchasing an annuity contract or an endowment contract from a life insurance company.

An individual retirement annuity must be issued in your name as the owner, and either you or your beneficiaries who survive you are the only ones who can receive the benefits or payments.

• Your entire interest in the contract must be nonforfeitable.
  
  
• The contract must provide that you can’t transfer any portion of it to any person other than the issuer.
  
  
• There must be flexible premiums so that if your compensation changes, your payment can also change.
  
  
• The contract must provide that contributions can’t be more than the deductible amount for an IRA for the year, and that you must use any refunded premiums to pay for future premiums or to buy more benefits before the end of the calendar year after the year in which you receive the refund.
  
  
• Distributions must begin by April 1 of the year following the year in which you reach age 701/2.

A SIMPLE IRA plan is a tax-favored retirement plan that certain small employers (including self-employed employees) can set up for the benefit of their employees. Your participation in your employer's SIMPLE IRA plan doesn’t prevent you from making contributions to a traditional or Roth IRA.

A Simplified Employee Pension (SEP) is a written arrangement that allows your employer to make deductible contributions to a traditional IRA (a SEP IRA) set up for you to receive such contributions. Generally, distributions from SEP IRAs are subject to the withdrawal and tax rules that apply to traditional IRAs..

Employer and Employee Association Trust Accounts. Your employer or your labor union or other employee association can set up a trust to provide individual retirement accounts for employees or members. The requirements for individual retirement accounts apply to these traditional IRAs.

There are limits and other rules that affect the amount that can be contributed to a traditional IRA.

For tax year 2019, annual individual contributions to traditional IRAs cannot exceed $6,000 in most cases. If you’re 50 or older, you can contribute up to $7,000 per year using catch-up contributions. For tax year 2018, the maximum annual contribution was $5,500.

Contributions on your behalf to a traditional IRA reduce your limit for contributions to a Roth IRA. Generally, your filing status has no effect on the amount of allowable contributions to your traditional IRA.

If contributions to your traditional IRA for a year were less than the limit, you can’t contribute more after the due date of your return for that year to make up the difference.

If contributions to your IRA for a year were more than the limit, you can apply the excess contribution in one year to a later year if the contributions for that later year are less than the maximum allowed for that year. However, a penalty or additional tax may apply.

Contributions can be made to your traditional IRA for a year at any time during the year or by the due date for filing your return for that year, not including extensions. You don’t have to contribute to your traditional IRA for every tax year, even if you can.

You may be able to claim a credit for contributions to your traditional IRA. If neither you nor your spouse was covered for any part of the year by an employer retirement plan, you can take a deduction for total contributions to one or more of your traditional IRAs of up to the lesser of: $6,000 ($7,000 if you are age 50 or older), or 100% of your compensation.

If you or your spouse was covered by an employer retirement plan at any time during the year for which contributions were made, your deduction may be further limited. If either you or your spouse was covered by an employer retirement plan, you may be entitled to only a partial (reduced) deduction or no deduction at all, depending on your income and your filing status.

Your deduction begins to decrease (phase out) when your income rises above a certain amount and is eliminated altogether when it reaches a higher amount. These amounts vary depending on your filing status.

You can't keep funds in a traditional IRA (including SEP and SIMPLE IRAs) indefinitely, eventually they must be distributed. If there are no distributions, or if the distributions aren't large enough, you may have to pay a 50% excise tax on the amount not distributed as required.

The amount that must be distributed each year is referred to as the required minimum distribution.

If you are the owner of a traditional IRA, you generally must start receiving distributions from your IRA by April 1 of the year following the year in which you reach age 701⁄2. April 1 of the year following the year in which you reach age 701⁄2 is referred to as the required beginning date.

You can withdraw or use your traditional IRA assets at any time. However, a 10% additional tax generally applies if you withdraw or use IRA assets before you reach age 591/2.

Amounts that must be distributed during a particular year aren't eligible for rollover treatment.

If you are the owner of a traditional IRA that is an individual retirement account, you or your trustee must figure the required minimum distribution for each year. If your traditional IRA is an individual retirement annuity, special rules apply to figuring the required minimum distribution.

Distributions from your traditional IRA may be fully or partly taxable, depending on whether your IRA includes any nondeductible contributions.

If only deductible contributions were made to your traditional IRA (or IRAs, if you have more than one), you have no basis in your IRA. Because you have no basis in your IRA, any distributions are fully taxable when received.

If you made nondeductible contributions or rolled over any after-tax amounts to any of your traditional IRAs, you have a cost basis (investment in the contract) equal to the amount of those contributions. These nondeductible contributions aren't taxed when they are distributed to you. They are a return of your investment in your IRA.

You must complete Form 8606, Nondeductible IRAs, and attach it to your return to report: nondeductible contributions you made to traditional IRAs; distributions from traditional, SEP, or SIMPLE IRAs; conversions from traditional, SEP, or SIMPLE IRAs to Roth IRAs; and distributions from Roth IRAs.

There is a lot more to be said about the IRAs and you should check Publication 590- A and Publication 590-B which explain all kinds of details including: setting up an IRA, contributing to an IRA, transferring money or property to and from an IRA, handling an inherited IRA, receiving distributions (making withdrawals) from an IRA, taking a credit for contributions to an IRA, or make a comparison of traditional and Roth IRAs.

Whether you check the IRS publications or not, you may want to contact a tax advisor to comply with this complicated area of the tax law, and keep up with our newsletters for regular updates on topics of general interest.