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What are IRAs? Here are the basics

Individuals can set up their own accounts for retirement through individual retirement accounts (IRAs), either the traditional variety or the Roth variety.

Individuals must have earned income in order to contribute to individual retirement accounts. Earned income is income from employment, as opposed to earnings from one's investments. Individuals must open an IRA account with a custodian such as a bank, credit union, or investment firm.

After selecting a custodian, an individual must deposit cash into his or her investment of choice. The largest contribution allowable for 2020 is the smaller of $6,000 or 100 percent of earned income.

The IRS has very specific rules regulating the contribution amounts and deductibility. It also has rules regarding withdrawals and when they can be made and how they are taxed. IRAs are an excellent way to save for retirement, but you should be aware of the rules, benefits, and drawbacks.

Traditional IRAs

The money contributed to a traditional IRA may be tax-deductible, depending on your income and whether you participate in an employer-sponsored retirement plan. The income the account earns is not taxable while it is in the accounts.

Contributions that are deductible will, however, be taxed when money is withdrawn from the account.

For 2020, a married couple in which both spouses work may contribute up to $12,000 in total, with $6,000 in each account (or 100 percent of earned income, if it is less). A person may make an additional $1,000 contribution beginning in the year that they turn 50 years old.

Millennials aren't contributing as much to their retirement. (Graphic: David Foster/Cashay)
Millennials aren't contributing as much to their retirement. (Graphic: David Foster/Cashay)

Roth IRAs

As in the traditional IRA, the most one individual can contribute to a Roth IRA for 2020 is $6,000. This limit is $1,000 higher for individuals age 50 or older. The most a married couple filing taxes jointly can contribute for 2020 is $12,000 ($6,000 each). These limits rise to $14,000 ($7,000 each) beginning in the year when individuals turn 50 years old.

How much one may contribute is limited for those above certain income levels. Contributions are not tax-deductible. However, withdrawals are not taxed when all rules have been properly followed.

You may simultaneously contribute to a traditional IRA, as long as the total placed into both accounts does not exceed the yearly limits.

You may make contributions for a particular year up until April 15 of the following year (unless that date falls on a weekend, in which case it will be extended). You must mark on the contribution form the year for which the contribution is made.

Dive deeper: Tax-deferred retirement plans: Everything you need to know

This content was created in partnership with the Financial Fitness Group, a leading e-learning provider of FINRA compliant financial wellness solutions that help improve financial literacy.

Read more information and tips in our Retirement planning section

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