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Individual Retirement Account (IRA)

Definition: An interest-earning retirement savings account in which the allowable contributions and earnings aren't taxed until the funds are withdrawn, after age 59 1/2.

One of the greatest advantages of the individual retirement account (IRA) is its relative simplicity, although the Taxpayer Relief Act of 1997 has made this retirement vehicle a bit more complex. For the most part, however, the paperwork and tax reporting requirements are minimal, and you're not obligated to cover any of your employees, as you're required to do with other types of retirement plans. You can set up or make annual contributions to an IRA any time up to the date your federal income tax return is due.

The biggest drawback to an IRA is that your maximum annual contribution is limited to the lesser of your earned income or $2,000. If you're not covered by an employer-provided retirement plan, you can make a tax-deductible IRA contribution, regardless of income.

For joint tax filers, even if one spouse is covered by an employer-provided retirement plan, the spouse who is not covered by a plan may make a tax-deductible IRA contribution if the couple's adjusted gross income is $150,000 or less. The amount you can deduct is decreased in stages above that income level and is eliminated entirely for couples with income over $160,000. Previously, the IRA deduction for a working or nonworking individual whose spouse was covered by a retirement plan was decreased between $40,000 and $50,000. Nonworking spouses and their partners can contribute up to $4,000 to IRAs ($2,000 apiece), provided the working spouse earns at least $4,000.

You may also want to consider the Roth IRA, a variety of IRA created by the Taxpayer Relief Act of 1997. Unlike the rules for traditional IRAs, contributions to a Roth IRA are nondeductible, but withdrawals are tax-free if certain conditions are met.

See also "Roth IRA."

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