What Is An IRA?

An individual retirement arrangement (IRA) is either an individual retirement account (with a bank, credit union, or other financial institution) or an individual retirement annuity (purchased from a life insurance company). However, the vast majority of IRAs are individual retirement accounts. Also, most individually owned annuities are commercial annuities and not IRAs as defined in this section. There are two main types of IRAs (traditional and Roth) but you may come across other IRA names, most of which are discussed briefly below.

Traditional IRAs

A traditional IRA is established under Internal Revenue Code (Code) section 408. With the exception of nondeductible contributions (see below) a traditional IRA is funded with deductible or pre-tax money, similar to regular 401(k) plan deferrals. As a result, the entire amount of any distribution (including investment gains) is taxed as ordinary income. Generally, a distribution before age 59 ½ will incur an additional 10% early withdrawal tax. Furthermore, an IRA owner must begin to take certain minimum distributions at age 70 ½.

Nondeductible Contributions: An individual retirement account, but not an individual retirement annuity, may contain contributions that exceeded the amount the owner was permitted to deduct from his/her taxes. These nondeductible contributions create a cost or tax basis that is not taxed when distributed. However, any related earnings are still taxed as ordinary income.

Roth IRAs

A Roth IRA is established under Code section 408A, and is funded with after-tax money that is not tax-deductible. As a result, the entire amount of any “qualified distribution” (including investment gains) is not taxed. Generally, a distribution is a “qualified distribution” if it occurs after (1) five years after the owner’s first Roth contribution, and (2) age 59 ½. There are special rules to calculate the five-year holding period for a former spouse who receives a transfer of Roth IRA assets due to divorce. A Roth IRA is subject to the same age 59 ½ early withdrawal tax as a traditional IRA, but it does not have to make minimum distributions at age 70 ½.

Deemed IRAs

An employer may establish a Deemed IRA for a participant in a “qualified plan,” a 403(b) plan, or a government sponsored 457(b) plan. A Deemed IRA can be either a traditional or Roth IRA and is governed by the corresponding distribution and tax rules.


A simplified employee pension (SEP), a salary reduction SEP (SARSEP), and a savings incentive match plan for employees (SIMPLE) are small employer sponsored retirement plans that can use traditional IRAs, but not Roth IRAs, as funding vehicles. Not surprisingly, an IRA is known as a SEP-IRA, SARSEP-IRA, or SIMPLE IRA depending on the type of plan. These IRAs are governed by the same distribution and tax rules as other traditional IRAs.

Inherited IRAs

As the name implies, an Inherited IRA is simply a traditional or Roth IRA inherited upon the death of the owner. Although the tax rules are the same as other traditional and Roth IRAs, the distribution rules may be different – especially if the beneficiary was not the owner’s spouse.

Rollover IRAs

A Rollover IRA is either a traditional or Roth IRA that was funded by a rollover distribution or direct transfer from another IRA or other qualifying retirement plan. The assets maintain the cost or tax basis from the distributing plan, but are now otherwise governed by the traditional or Roth IRA rules.

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