An Individual Retirement Account is an investing tool used by individuals to earn and earmark funds for retirement savings. There are several types of IRAs: Traditional IRAs, Roth IRAs, SIMPLE IRAs and SEP IRAs.
Traditional and Roth IRAs are established by individual taxpayers, who are allowed to contribute 100% of compensation (self-employment income for sole proprietors and partners) up to a set maximum dollar amount. Contributions to the Traditional IRA may be tax deductible depending on the taxpayer's income, tax filing status and coverage by an employer-sponsored retirement plan. Roth IRA contributions are not tax-deductible.
With the exception of Roth IRAs, where eligible distributions are tax-free, eventual withdrawal from an IRA is taxed as income; including the capital gains. Because income is likely to be lower after retirement, the tax rate may be lower. Combined with potential tax savings at the time of contribution, IRAs can prove to be very valuable tax management tools for individuals. Also, depending on income, an individual may be able to fit into a lower tax bracket with tax-deductible contributions during his or her working years while still enjoying a low tax bracket during retirement.
An Education IRA, or a Coverdell ESA CD, was created by Congress to provide people with a way to save, tax-free, for a child's education, whether it be for K-12, college, graduate school or any other formal education that child may pursue.
While parents will find this to be a helpful and less painful way to save for a child's education, the tax deduction applies to anyone who makes a contribution to an education IRA. Therefore, if you are a grandparent who is interested in setting aside funds for a grandchild's education, a tax deduction is available to you, too.
Because these accounts are designed for retirement and other long-term savings, federal regulations require a penalty for early withdrawal. Other tax penalties may also apply. Please consult your tax professional for more information.