An Individual Retirement Account, or IRA, is a tax-deferral advice allowed by tax law. The account, typically opened by the taxpayer, can be funded up to certain limits with pre-tax dollars (except for the Roth IRA, which works differently). This means the contributions to these accounts are tax-deductible. Moreover, when the account earns income, such as from dividends or capital gains when its assets are sold, there is no income tax on this income. However, when the money is eventually withdrawn, it is subject to income tax.
There are many types of IRAs, with the “Traditional” IRA being the most basic. Other types of IRAs include SEP and SIMPLE IRAs, which are devices primarily used by small businesses and sole business owners. There are limits on how much can be contributed to each type and there are also limits on how much income the taxpayer can make and the still take advantage of these devices.
IRA assets withdrawn before age 59 ½ are subject to a 10% penalty, with exceptions for certain withdrawal purposes. Starting at age 70 ½, “required minimum distributions” must be taken, and these increase as the account holder gets older.