Setting up an Individual Retirement Arrangement (IRA)



 
An IRA is easy to set up—just fill out a simple application at the financial institution you choose. IRAs are self-directed; you decide how to invest the money, and you're also responsible for putting in only the amount you're entitled to each year. You must also report your annual contribution to the IRS, on your basic return if it's deductible and on Form 8606 if it's not. You may contribute a lump sum, or spread out your contribution over 15 months.

Traditional IRA - The traditional IRA can be set up anytime at a bank, financial institution, mutual fund, or life insurance company. Traditional IRAs are regulated by the IRS, and when establishing one you must arrange a contract between you and your trustee/custodian.

Roth IRA - The Roth IRA can be set up anytime at a bank, financial institution, mutual fund, or life insurance company. Roth IRAs are regulated by the IRS, and when establishing one you must arrange a contract between you and your trustee/custodian.

Simple IRA - You and your employer must sign a contract stating what percentage or set dollar amount of your compensation will be contributed to your account and your employer must match the amount contributed. If your employer chooses the trustee/custodian, you must use Form 5305-SIMPLE. If you are to choose the trustee/custodian, you must use Form 5304-SIMPLE. You must also sign a contract between you and your trustee (Form 5305-S) or custodian (Form 5305-SA).
  • SIMPLE IRAs must be set up between January 1 and October 1 (if your sponsor did not previously set up a SIMPLE plan) and on January 1 (if your sponsor did previously set up a SIMPLE plan).
Simplified Employee Pension (SEP) IRA - You must establish a traditional IRA to which your employer will make SEP contributions. Some financial institutions require that your traditional IRA account be labeled as a SEP IRA, and others will allow your employer to make SEP contributions to an account labeled as a traditional IRA.
  • The employee and employer must sign a formal agreement using the Internal Revenue Service (IRS) model SEP using Form 5305-SEP, Simplified Employee Pension - Individual Retirement Accounts Contribution Agreement, or a prototype. Prototypes are offered by banks, insurance companies, and other financial institutions.

Can I convert from a traditional IRA to a Roth IRA? How?

Many people consider the Roth IRA more attractive than the traditional IRA. However, some already have a traditional IRA when they realize this. Is it possible to convert from a traditional IRA to a Roth IRA? Yes, it is possible, but the “rollover” must be qualified: you must wait 60 days after opening your traditional IRA before you may convert. For more information, see IRS Publication 590. In addition, your adjusted gross income (AGI) cannot exceed $100,000—this goes for single filers as well as for joint filers and head-of-household filers. Funds transferred from a traditional IRA to a Roth IRA that weren’t taxed will be taxed at your normal tax rate.

In addition, because a conversion is a “qualified” distribution, you would not be charged the 10% penalty that is charged to nonqualified distributions. However, you would be charged a penalty is you remove funds from the Roth IRA early.