Types of IRAs (Individual Retirement Account)*

There are a number of different types of IRAs which may be either employer provided plans and self-provided plans. The types include:

• Roth IRA - contributions are made with after-tax assets, all transactions within the IRA are tax-free, and withdrawals are usually tax-free. Named for Senator William Roth.
• Traditional IRA - contributions are often tax-deductible (often simplified as "money is deposited before tax" or "contributions are made with pre-tax assets"), all transactions and earnings within the IRA are tax-free, and withdrawals at retirement are taxed as income (except for contributions that were not deducted).
• SEP IRA - a provision that allows an employer (typically a small business or self-employed individual) to make retirement plan contributions into a Traditional IRA established in the employee's name, instead of to a pension fund account in the company's name.
• SIMPLE IRA - a simplified employee pension plan that allows both employer and employee contributions, similar to a 401(k) plan, but with lower contribution limits and simpler (and thus less costly) administration. Although it is termed an IRA, it is treated separately.

There are two other subtypes of IRA, named Rollover IRA and Conduit IRA, that are obsolete under current tax law (their functions have been subsumed by the Traditional IRA) but this tax law is set to expire unless extended. What was formerly known as an Educational IRA is now called a Coverdell Education Savings Account.

Starting with the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), many of the restrictions of what type of funds could be rolled into an IRA and what type of plans IRA funds could be rolled into were significantly relaxed. Additional acts made some further relaxations of restrictions. Essentially most retirement plans can be rolled into an IRA after meeting certain criteria, and most retirement plans can accept funds from an IRA.

Funding an IRA

An IRA can only be funded with cash or cash equivalents. Attempting to transfer any other type of asset into the IRA is a prohibited transaction and disqualifies the IRA from its beneficial tax treatment. (Of course, rollovers, transfers, and conversions between IRAs and other retirement accounts can include any asset.) The maximum for an IRA contribution in the year 2006 is $4,000 for an individual under the age of 50. Individuals aged 50 and older can contribute up to $5,000. Keep in mind, this limit is for Roth IRAs, traditional IRAs, or some combination of the two. You cannot put more than $4,000 into your Roth and traditional IRA combined. So if you are 45 and put $3,500 into your traditional IRA this year so far, you can either put $500 more into your traditional IRA or $500 in your Roth IRA- no more. However, because this is still before the filing deadline (April 15, 2007) for calendar year 2006, the cash method taxpayer could get the full $4000 limit for the Roth by simply calling the $3,500 a Roth and NOT claiming the $3,500 above the line (i.e reduces AGI) deduction and making the remaining $500 a Roth. There may be an additional administrative step needed so that the trustee which holds the IRA proceeds actually retiles or transfers the $3500 Traditional proceeds into the Roth category for their internal bookkeeping to survive an IRS audit. The same is true of individuals over 50, but the combined limit is currently (2006) $5,000.

Valid investments inside an IRA

Once money is inside an IRA, the IRA owner can direct the custodian to use the cash to purchase most types of securities, and some non security financial instruments. Some assets cannot be held in an IRA such as collectibles (e.g. art, baseball cards, and rare coins) and life insurance. Some assets are allowed subject to certain restrictions. For example an IRA cannot own real estate if the IRA owner has any involvement with that real estate, for instance as his personal residence or as a property manager (or if a relative fills one of these roles).

Most IRA custodians limit available investments to traditional brokerage accounts such as stocks, bonds, and mutual funds, and do not permit real estate in an IRA unless it is held indirectly via a security such as a real estate investment trust (REIT). True self-directed IRA custodians/administrators permit real estate and other non-traditional assets. They may be found via a web search. They typically charge fees based on asset values. There are certain special restrictions on real estate held in an IRA (the IRA owner cannot benefit from the property in any way, i.e. they can not use it). There are many companies who educate clients on the rules for self-directed IRA investors who need assistance.

An IRA may borrow money but any such loan must not be personally guaranteed by the owner of the IRA, and also the loan must be secured solely by assets in the IRA (in other words, a non-recourse loan). Also, the owner of the IRA may not pledge the IRA as security against a debt.

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* source: Wikipedia  www.wikipedia.com