Individual Retirement Accounts Explained

Too many Americans postpone or neglect saving for retirement believing Social Security benefits will be sufficient as a primary source of income. In most cases, this is not true. IRAs offer you tax-advantaged ways to make building your retirement nest egg easy. IRA funds deposited at DCU are federally-insured to $250,000 per member by NCUA and are backed by the full faith and credit of the U.S. government.

This part of StreetWise explains what IRAs are, how they work, and how they compare to other types of retirement plans.

Individual IRA Plans  –  401(k), IRA, or Both?  |  Traditional IRA  |  Roth IRA
Which is for You  –  Traditional or Roth?  |  Coverdell Education Savings Account  |  Shopping for IRAs

Account Types at DCU  –  Certificate IRAs  |  Money Market IRAs  |  Savings IRAs

Uninsured IRA Investments  –  Stocks, Bonds, and Mutual Funds

Small Business Plans  –  Simplified Employee Pension (SEP)  |  Savings Incentive Match Plan for Employees (SIMPLE)

To adequately prepare for retirement, many financial experts recommend you fully fund your 401(k), then deposit the maximum possible in an IRA. A 401(k) plan is a retirement vehicle sponsored by employers. Employees make pre-tax contributions into the plan. The employer matches a portion of the employee's contribution – usually 50% to 100% – up to a percentage of the employee's salary. The match often represents a significant portion of the investment's growth. Tax laws limit the amount of contributions employees can make.

Distributions are taxed upon withdrawal. Generally, the employer contributions are subject to vesting. This means the employee must be in the plan for a pre-set period of time before the contributions totally belong to the employee – even if they change jobs.

When someone leaves an employer, they often get a distribution from their 401(k) and possibly a pension plan. The proceeds of these distributions can be rolled directly into a Traditional IRA (see below) without any taxes or penalties.

Talk to your employer to see if a 401(k) plan is available to you and how to contribute to it. If your employer does not have a plan, opening an IRA is even more essential to your comfortable retirement.

Contributions to traditional IRAs (under certain circumstances) and the earnings on them aren't taxed until withdrawal. At that time, withdrawals are taxed at your income tax rate. Ten percent penalty taxes may apply if you withdraw before age 59½.

In 2007 you can contribute up to $4,000 a year or 100% of your earned income, whichever is less. If you are married, you can contribute up to $8,000 or 100% of your combined income, whichever is less, between each spouse's IRAs. For the year 2008 and beyond you can contribute up to $5,000 a year ($10,000 for married couples). Workers age 50 and older can play "catch-up" with their retirement savings by contributing up to 100% a year over the maximum contribution limits. You can make contributions up to April 15 for the prior tax year.

You can make tax penalty-free withdrawals for several reasons. You can pay first-time home-buying expenses ($10,000 lifetime limit) for you, your spouse, children, grandchildren, or parents. You can also pay qualified higher education expenses for you, your spouse, children, or grandchildren not covered by other education assistance.

Penalty-free withdrawals are also allowed for death, disability, medical expenses that exceed 7.5% of your adjusted gross income, and to purchase health insurance if you have received unemployment compensation for twelve weeks or more.

Minimum distributions are required beginning at age 70½. If you receive a distribution from a pension, 401(k), or other company retirement plan, you can roll the entire amount into an IRA and defer the taxes until withdrawal.

If you are not covered by an employer-sponsored retirement plan, you can deduct your entire contribution. If you are, it's still deductible if you're single with adjusted gross income (AGI) of $33,000 or less, or married with AGI of $53,000 or less. Many non-working spouses can now deduct $4,000 in contributions even when their spouse is covered by a retirement plan.

At DCU, federally-insured Traditional IRAs are available as IRA Certificates, Money Market IRAs, and Savings IRAs .

The new Roth IRA offers tax-free growth when you hold it for at least five years and take distributions after you reach 59½. Unlike traditional IRAs, you can keep your account intact beyond age 70½ and can continue to make contributions. Being covered by a retirement plan doesn't affect your ability to contribute.

You can make tax penalty-free withdrawals for several reasons. You can pay first-time home-buying expenses ($10,000 lifetime limit) for you, your spouse, children, grandchildren, or parents. Penalty-free withdrawals are also allowed for death, disability, medical expenses that exceed 7.5% of your adjusted gross income, and to purchase health insurance if you have received unemployment compensation for twelve weeks or more.

In 2007 you can contribute up to $4,000 a year or 100% of your earned income, whichever is less. If you are married, you can contribute up to $8,000 or 100% of your combined income, whichever is less, between each spouse's IRAs. For the year 2008 and beyond you can contribute up to $5,000 a year ($10,000 for married couples). Workers age 50 and older can play "catch-up" with their retirement savings by contributing up to 100% a year over the maximum contribution limits.

If you're married with adjusted gross income (AGI) below $160,000, or single with AGI below $110,000, you can make annual contributions – up to $4,000 if AGI is $150,000 or $95,000 respectively. If your AGI is under $100,000, you can roll your existing IRAs, deductible and non-deductible, into a Roth IRA without penalty. However, if you do, you'll owe income tax on all previously untaxed contributions and earnings.

At DCU, federally-insured Roth IRAs are available as IRA Certificates, Money Market IRAs , and Savings IRAs.

Deciding which type is best and whether to transfer your current accounts to a Roth IRA is a complicated decision. You must consider your current and future tax brackets, other assets available, your age, your planned retirement age, and whether you built your current IRAs with deductible or non-deductible contributions. You also need to consider any other retirement investments you have. You can have both types of IRAs, but combined contributions can't exceed $4,000 a year. Your tax advisor can help you weigh these and other factors to make the best decision.

In general, a Traditional IRA may be better if you don't participate in an employee-sponsored retirement plan, expect to be in a lower tax bracket at retirement, and need the tax deduction. A Roth IRA may be better if you expect to be in the same or a higher tax bracket at retirement and you're starting at age 18 to 44. Because there is no mandatory distribution age, a Roth may also be better if you won't need your IRA for living expenses and want to leave sizable assets to your heirs.

When converting a Traditional IRA to a Roth, a good rule of thumb is to consider it if you can afford to pay the taxes from other savings or current earnings, or if you won't need the IRA funds during retirement and want to pass funds to your heirs. You generally should not convert if you are within five years of retirement or will need to dip into the IRA to pay the taxes.

The Coverdell Education Savings Account is not an IRA at all, but a new way to save for qualified higher education expenses such as tuition, fees, books, supplies, and equipment (including the purchase of a computer, educational software and internet access) required for college, vocational, public and private elementary and high schools.

Education Savings Accounts are available only to children under 18. Each child can receive up to $2,000 per year in after-tax contributions from relatives and friends whose adjusted gross income (AGI) is $220,000 or less if married, or $110,000 if single. Earnings grow tax-free.

Contributions can be made for beneficiaries with special needs (determined by The Treasury) over age 18. CESA balances for those with special needs are not required to be distributed by age 30.

Distributions taken after five years are tax free and must be used for qualified higher education expenses. Tax penalties apply for early withdrawals and use for non-qualified expenses.

At DCU, federally-insured Coverdell Education Savings Accounts are available as IRA Certificates, IRA Money Market Accounts, and Savings IRA.

When you are ready to open an IRA, there are certain things you want to look for to ensure you get the best possible deal:

IRA Certificates earn DCU's highest dividend rates on your retirement funds. For a low minimum balance of $100%, you can choose a Certificate with terms from three months to five years.

Dividends are compounded daily on the entire account balance and credited monthly. Dividend rates are fixed for the entire term. There are no annual fees. A dividend penalty may be incurred for an early withdrawal.

Highest Dividend Rates with Loyalty Checking Plus – If you have a Loyalty Checking Plus relationship when you open or renew a DCU Certificate, you'll automatically receive the highest published dividend rate for that certificate. Other great rates are available. You can boost it another ¼% for the next term when you add at least $5,000 to the balance at maturity. IRA Certificates can be used for Traditional, Roth, Education, and for Small Business Plans.

See Rates for current dividend rates and terms.

DCU Money Market IRAs have five dividend rate tiers based on your daily balance. The greater your balance, the higher the dividends you earn. See Rates for current tiers and dividend rates.

Dividends are compounded daily and paid monthly. Dividend rates can change weekly. A minimum balance of only $1,000 is required to earn dividends. Contributions and withdrawals can be made anytime without a DCU penalty.

You can contribute to your Money Market IRA through automatic transfer from your savings or checking account. Automatic transfers allows you to spread your annual maximum $4,000 contribution throughout the year. If you contribute $76.92 per week or $333.33 per month, you will accumulate almost $4,000 by year end. With unrestricted withdrawals, you can move your contribution to a DCU IRA Certificate for higher returns or roll it over into another qualified retirement investment.

Money Market IRAs can be used for Traditional, Roth, Education, and for Small Business Plans.

DCU Savings IRAs offer good dividends with no minimum balance or term requirement. See Rates for current dividend rates.

Dividends are compounded daily and paid monthly. Dividend rates can change weekly. Contributions and withdrawals can be made anytime without a DCU penalty.

You can contribute to your Savings IRAs through automatic transfer from your savings or checking account. Automatic transfers allows you to spread your annual maximum $4,000 contribution throughout the year. If you contribute $76.92 per week or $333.33 per month, you will accumulate almost $4,000 by year end. With unrestricted withdrawals, you can move your contribution to a DCU IRA Certificate for higher returns or roll it over into another qualified retirement investment.

Savings IRAs can be used for Traditional, Roth, Education, and for Small Business Plans.

Uninsured IRAs offer the potential for greater return than insured IRAs. But with the greater return comes investment risk – the potential loss of principal.

Most financial advisors suggest a balanced mix of riskier investments and safer investments. The balance would change as you get closer to retirement, shifting more funds toward completely safe insured investments. People close to retirement, when they will need to begin drawing on funds, can ill-afford a market downturn that erases a significant portion of their retirement nest egg. DCU provides access to uninsured IRA investment opportunities through three investment companies through DCU Financial..

A SEP allows employers to set up a type of individual retirement account, known as a SEP-IRA, for themselves and their employees. Employers must contribute a uniform percentage of pay for each employee. Employer contributions are limited to the lesser of 25 percent of an employee's annual salary or $40,000. (Note: this amount is indexed for inflation and will vary). SEPs can be started by most employers, including those who are self-employed.

Workers age 50 and older can play "catch-up" with their retirement savings by contributing up to 100% a year over the maximum contribution limits.

Businesses are not locked into making contributions every year. You can decide how much to put into a SEP each year – offering you some flexibility when business conditions vary. A sole proprietor, partnership, or corporation can establish a SEP for the benefit of all employees.

DCU offers SEP-IRAs as a vehicle for funding the pension plan. For more information on retirement solutions for small businesses, see the U.S. Department of Labor.

This savings option for employers of 100 or fewer employees involves a type of IRA and is the result of new legislation, the Small Business Job Protection Act of 1996.

A SIMPLE plan allows employees to contribute a percentage of their salary each pay check and to have their employer match their contribution. Under SIMPLE plans, employees can set aside up to $7,000 each year by payroll deduction. Workers age 50 and older can play "catch-up" with their retirement savings by contributing up to 100% a year over the maximum contribution limits.

Employers can either match employee contributions dollar for dollar – up to three percent of an employee's wage – or make a fixed contribution of 2 percent of pay for all eligible employees instead of a matching contribution.

Employees are 100% vested in contributions, get to decide how and where the money will be invested, and keep their IRA accounts even when they change jobs.

DCU offers SIMPLE IRAs as a vehicle for funding this plan. For more information on retirement solutions for small businesses, see the U.S. Department of Labor.

Terms and conditions applicable to DCU's IRAs can be found in the IRA Disclosure Statement, Truth-in-Savings Disclosure and Agreements (Savings and Money Market IRAs), Certificate Disclosure and Agreement (Certificate IRAs), Rate Information Brochure, and Schedule of Fees and Service Charges. For a copy of any of these disclosures or for more information, visit a DCU branch or call the Information Center.

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