What Is an IRA?

An Individual Retirement Account or Annuity (IRA) allows workers and their spouses to set aside funds for retirement on a tax-deferred basis. Once heralded as the little guy's tax shelter, the popularity of these arrangements (and the revenue loss to the government) prompted the federal government to restrict considerably those who could deduct their IRA contributions.

Although anyone with earned income (and certain spouses of workers) can open an IRA and accumulate tax-deferred earnings, only workers who are not active participants in (1) a qualified employer plan, (2) a Keogh plan, (3) a 403(b) plan or certain other designated retirement plans are eligible to take a full IRA federal income tax deduction without regard to their Adjusted Gross Income (AGI) level. IRAs cannot be transferred or assigned. Distributions from the IRA must be made to the IRA owner or a named beneficiary.

In recent years the traditional IRA just described has been supplemented by an alternative individual retirement account known as a "Roth IRA." Contributions to a Roth IRA by eligible individuals are nondeductible, but earnings grow income-tax-free and distributions are also income-tax-free if certain requirements (discussed later) are met.

So-called "education IRAs" have been officially renamed "Coverdell education savings accounts," and are discussed elsewhere in this service.  As first noted above, the enhancements to IRAs provided by EGTRRA were scheduled to sunset at the end of 2010. PPA has made those provisions permanent, so the discussion of IRAs in this section continues to apply through 2010 and beyond.

The Purpose of IRAs

The purpose of IRAs is threefold. First, IRAs provide retirement benefits to workers and spouses who may not be covered by another plan. Second, the tax-deferral of IRA earnings and the tax deduction for contributions—if available—give the IRA owner an opportunity to conserve dollars that would otherwise be lost to current taxes. And third, the IRA owner has more dollars at work than if the IRA was depleted by annual taxes on investment earnings.

Individual Retirement Accounts

Contributions to Traditional IRAs

Deductions for Contributions to Traditional IRAs

Distributions from Traditional IRAs

Roth IRAs