Retirement may look like it is a long way off, but time has a way of passing faster than you think, and the sooner you start planning for those golden years, the more resources you will have to draw on. Putting your retirement dollars into a tax-advantaged account such as an individual retirement account can make your savings grow even faster. There are a number of different types of IRAs available, including traditional and SIMPLE IRAs.
Before the passage of the Employee Retirement Income Security Act, or ERISA, in 1974, workers who were self-employed, or who worked for a company that did not offer a pension plan, had little access to tax-advantaged retirement programs. ERISA authorized individual retirement accounts for these individuals. Contributions were limited to $1,500 per year, but the worker could deduct this amount from his income taxes, and growth in the account occurred tax deferred. The effect on retirement savings was so good that Congress later expanded the program to include all taxpayers with earned income who were under the age of 70 1/2, allowing them to participate regardless of whether they were covered by another qualified retirement plan. Congress also authorized the creation of SIMPLE IRA plans for small businesses to help them provide a simple retirement vehicle for their employees.
Any taxpayer at any age up to 70 1/2 years can set up and contribute to a traditional IRA, provided they received taxable compensation from work performed during the tax year. This means that even a baby under one year old who earns compensation for working as a model for a print advertisement can have a traditional IRA. SIMPLE IRA plans are established by small businesses that employ no more than 100 employees who earned at least $5,000 during the last calendar year. Once a small business establishes a SIMPLE IRA plan, all employees who have earned at least $5,000 during any two previous calendar years, and who are expected to earn at least $5,000 in the next calendar year must be included in the plan. Workers who are covered by a SIMPLE IRA plan may also have a traditional IRA.
The amount that can be contributed to either a traditional IRA and a SIMPLE IRA is limited by tax law and regulations, which are adjusted from time to time. For the 2009 tax year, the contribution limit for traditional IRAs was the lesser of the worker's total taxable compensation for the entire year or $5,000. Workers who were at least 50 years old could contribute up to $6,000. Employees who are covered by a SIMPLE IRA plan can contribute up to $11,500 in tax-deferred compensation for the 2010 and 2011 tax years. Employee contributions to a SIMPLE IRA are considered by the IRS to be a salary reduction and are taken out of the employee's paycheck before she receives it.
Contributions made to a traditional IRA may be deducted from an individual's federal income taxes when she files her 1040 each year. Taxpayers can continue to make tax-deductible contributions into an IRA up to the date they file their tax return, but no later than April 15, even if they file for an extension. The earnings generated within the IRA grow on a tax deferred basis and are not taxed until they are withdrawn, presumably after the taxpayer has retired and is in a lower tax bracket. Contributions made to a SIMPLE IRA are also made with pretax dollars and enjoy the same tax deferred growth potential. SIMPLE IRA plan rules typically require the employer to make matching contributions of up to 3 percent of each eligible employee's total compensation.
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