IRA Basics

Photo credit: jb

This article is intended only to provide you with the basics of IRAs, to get you started with your education.  These days nearly everyone has an IRA – so it’s important to understand IRA basics.  The following information holds true for both kinds of IRAs:  traditional IRA and Roth IRA plans.

IRA accounts* can be held at a variety of institutions: banks and credit unions, brokerages, mutual fund companies and insurance companies.  Essentially, if it is a financial institution, quite likely there is an IRA offering.

*Notice that I refer to “IRA accounts”. IRA stands for Individual Retirement Arrangement, not Individual Retirement Account, as many people think. Therefore it is a proper reference as “IRA accounts”. Also, see the note below about the “Individual” reference.

Establishing an IRA

Typically, an IRA account is established by filling out an application. In the application you must identify yourself by name, address, and social security number.  You’ll be asked to name a beneficiary – a decision not to be taken lightly (see Choosing a Beneficiary for Your IRA for details).  Having filled out the necessary paperwork, generally you will send off the application, along with your contribution to the account. Sometimes (in fact most of the time anymore) this process can be completed online, quickly and easily.

In any given year, there is a specific limit to the amount you are allowed to contribute to ALL IRAs.  This means the total of all of your contributions, whether to a traditional IRA or a Roth IRA, or any combination of both, cannot exceed the annual limit (see here for the 2020 limits).  If you are age 50 or older, there is an additional “catch-up” contribution allowed.

The limit on annual contributions is for all IRAs. This means that you can make the annual contribution to one account, or in total to several accounts if you wish, but you can only make contributions up to the annual limit in any single tax year.

Rollover contributions, on the other hand, do not have an annual limit. You can rollover as much as you like from one IRA to another, or from an employer-based plan (such as a 401(k) or 403(b) plan) to an IRA. You can also convert any amount that you like from a traditional IRA to a Roth IRA – no annual limit there either.

In order to make a contribution to an IRA account, you must have earned income. This is income in the form of wages, salary, self-employment and the like. Unearned income, such as interest, dividends and capital gains (as well as pension or other retirement income) is not included when determining whether you have earnings to allow for an IRA contribution. If you have no (or very low) income but your spouse has income, you may be eligible for a spousal IRA contribution.

It is important to understand that the term “Individual” in Individual Retirement Arrangement is taken quite literally:  IRAs are Individual instruments, not jointly held, so the limits mentioned above are per individual, not per household. As such, each member of a married couple may be eligible for differing amounts of IRA contribution, determined in part by income, age, and by coverage in other retirement plans.

When one member of a married couple dies, the IRA doesn’t necessarily automatically become the property of the surviving spouse. This only happens if the surviving spouse is designated as the sole primary beneficiary of the IRA. Beneficiary designations supersede provisions in a last will and testament – allowing for simple transfer of IRA funds to your heirs without court intervention.