Individual Retirement Accounts (IRAs) function as personal tax-qualified retirement savings plans. Anyone who works, whether as an employee or self-employed, can set aside up to $5,000 in an IRA in 2009 and in 2010 (indexed for inflation in future years), and the earnings on these investments grow, tax-deferred, until the eventual date of distribution. Persons 50 and over may contribute an addition $1,000 annually. Moreover, certain individuals are permitted to deduct all or part of their contributions to the IRA. Also, since 1998, certain individuals can also set up Roth IRAs to which contributions are not deductible, but from which withdrawals at retirement won't be taxed. You can have both types of IRAs but you may only contribute an annual total of $5,000 for 2009 and for 2010 between the two accounts.

IRAs are set up as trusts or custodial accounts for the exclusive benefit of an individual and his or her beneficiaries. You can set up an IRA simply by choosing a bank, mutual fund, brokerage house or other financial institution to act as trustee or custodian. The institution will give you the necessary forms to complete. A lesser-known alternative is to purchase an individual retirement annuity contract from a life insurance company. An individual cannot be his own trustee.

You must begin taking distributions from an IRA no later than April 1st of the year following the year in which you reach age 70.5, or the year in which you retire, whichever is later. There's an exception to this rule for Roth IRAs, which carry no mandatory distribution requirements. The mandatory distribution requirements were waived for 2009 by law.

Did You Know? According to a December 17, 2003, Congressional Research Service report, savings held in IRAs have grown steadily from $85 billion in 1983 to $2.5 trillion at the end of 2001. Although the amount of contributions fell dramatically after 1985, tax law changes have stimulated new contributions since 1997. A survey cited in the report also indicates that about 45.2 million households (or 41 percent of all households) owned an IRA in mid-2003. Of this amount, 36.4 million households had traditional IRAs, 16 million had Roth IRAs, and 8.2 million had employer sponsored IRAs.

Amount. The most that you can contribute in a year to an IRA in 2009 and 2010 is the smaller of $5,000 or an amount equal to the compensation includible in income for the year. Those 50 years old and above will also be allowed to make additional $1,000 catch-up contributions to an IRA each year to help them save more for retirement.

The same limit applies even if the individual has more than one IRA, or more than one type of IRA. When both a husband and wife have compensation, the limit applies separately to each, so that as much as $10,000 can be contributed for 2009 and 2010 ($12,000 if both are 50 or over).

In later years, IRA contribution limits will continue to increase due to cost of living adjustments. The table below summarizes the contribution limits imposed from 2006 through 2010.

Earned income requirement. The contribution must be from compensation, which means wages, salaries, commissions and other sources of earned income. It does not include deferred compensation, retirement payments or portfolio income such as interest or dividends.

Nonworking spouses. Up to $5,000 may be contributed to an IRA on behalf of a nonworking spouse in 2009 and 2010 ($6,000 if the nonworking spouse is age 50 or over). Separate accounts must be used for each spouse. The couple must file a joint tax return to claim the deduction, and the combined compensation of both spouses must be at least equal to the amount contributed to both spouses' IRAs.

Timing. An IRA can be established and a contribution made after year-end. It must be made no later than the due date for filing the income tax return for that year, not including extensions. This generally means that you have until April 15th of the following year to make the contribution and deduct it on your tax return. You don't have to contribute the full amount allowed every year. You may skip a year or even several years. You may resume making contributions in a later year, but you cannot "catch up" for years no contribution was made.

Excess contributions. If you contribute more than the allowable amount, a 6 percent excise tax penalty will be assessed. This penalty is due for the year of the excess contribution and for each year thereafter until corrected.

Disallowed contributions. No contributions may be made to an inherited IRA in a form other than cash, or during or after the year in which the individual reaches age 70.5. For Roth IRAs, however, there is no upper age limit on when contributions can be made.

Deductible IRAs. Everyone is eligible to establish and maintain an IRA, but whether the contributions into the IRA will be deductible depends on the individual's (or, if married, the couple's) income level and whether or not the individual is covered by another pension plan at work.

If neither the individual nor spouse is covered under another retirement plan, they may take full advantage of the tax deduction for the amount contributed, regardless of their income level.

If the individual making the contribution is covered under another retirement plan, the amount of the contribution eligible for deduction is determined by the filing status and adjusted gross income of the couple, as shown on the Form 1040 Income Tax Return. The following table is in effect for 2009.

These dollar amounts have been adjusted for inflation through the past several years, and will continue to be adjusted in the future.

If the individual making the contribution is not covered by another retirement plan at work, but his or her spouse is covered by such a plan, the non-covered individual may make deductible contributions to an IRA, but the deductibility of the contributions is still phased-out if joint income is too high. The deductibility of contributions phases-out at income levels ranging from $166,000 to $176,000 in 2009. For 2010, the income range for phasing-out the deduction is $167,000 to $177,000. Such inflation adjustments of the phase-out range will continue in future years.

Roth IRAs. Some taxpayers can set up Roth IRAs that are "backloaded": that is, the contributions are not deductible, but the withdrawals from the account, including all the buildup in value over the years, are tax-free as long as certain conditions are met. The conditions are that the withdrawals are made five years or more after the account was opened, and after you attain age 59.5 or have become disabled. Joint filers with income under $166,000 in 2009 or $167,000 in 2009 can make full contributions to Roth IRAs; for those with income between $166,000 and $176,000 in 2009, or income between $167,000 and $177,000 in 2010, the contribution amount is phased down, until it is phased out completely at $176,000 in 2009 and $177,000 in 2010. For singles, the phase-out range is between $105,000 and $120,000 in 2009, and remains the same in 2010. These amounts will continue to be adjusted for inflation in future years.

You can convert a "regular" IRA to a Roth IRA in any year that your annual adjusted gross income is under $100,000 (single or joint). The catch is that you must pay income tax for the year of conversion on the entire amount that you convert. The converted amount must remain in the account for five years; if it is withdrawn prematurely a 10 percent penalty will apply and any tax due on the conversion that has not already been paid will become due in the year of the withdrawal.

Starting in 2010, the $100,000 adjusted gross income ceiling for converting a regular IRA to a Roth IRA is eliminated. Thus, anyone with a regular IRA can convert it to a Roth IRA. A conversion is treated as a taxable distribution, but is not subject to the 10-percent early withdrawal penalty. Also, taxpayers who convert in 2010 are given the option to elect to recognize the conversion income in 2010 or average it over the next two years.As a result, the income tax due on the conversion can be deferred over the following two years.

Did You Know? The elimination of the $100,000 ceiling should have higher-income taxpayers and their financial advisors salivating. High-income taxpayers with substantial amounts in traditional IRAs previously were shut out of the benefits of conversion. Now, anyone can convert to a Roth IRA starting in 2010. There are several tax planning opportunities to consider now, though. Although this provision does not extend to 401(k) plans, nothing would prevent Roth IRA conversions of traditional IRAs that have received proceeds of 401(k) balances when an individual leaves employment. Nor does the new law prevent high-income taxpayers from making a 2009 contribution to a traditional IRA prior to April 15, 2010, in anticipation of converting to a Roth IRA during 2010. Keep in mind that 2010 is also the last year for the current low income tax rates before they sunset in 2011. The rush to do Roth conversions in 2010 may be historic, especially if Congress does not extend the lower tax rates. So, plan ahead to take full advantage of this change in the law.

Nondeductible contributions. To the extent that you can't meet the requirements for deductible IRAs or Roth IRAs, you may still make a nondeductible contribution to an IRA. However, your total annual contributions to any type of retirement IRA may not exceed $5,000 in 2009 or 2010 ($6,000 if you are at least age 50). Just be sure that you don't mix deductible and nondeductible contributions (or Roth IRAs, or converted Roth IRAs) in the same account. The earnings on nondeductible contributions will still accumulate on a tax-deferred basis, and when you make withdrawals from your account, you'll be able to receive your original contributions (but not the additional buildup in value over the years) tax-free. To report nondeductible contributions, you must file Form 8606 with your tax return.

Transfers and rollovers. The shifting of funds from one IRA trustee/custodian directly to another trustee/custodian is called a transfer. It is not considered a rollover because nothing was paid over to you. A transfer is tax-free and there are no waiting periods between transfers.

A rollover, in contrast, is a tax-free distribution to you of assets from one retirement plan that you then contribute to a different retirement plan. Under certain circumstances, you may either roll over assets withdrawn from one IRA into another, or roll over a distribution from a qualified retirement plan into an IRA. If the distribution from a qualified plan is made directly to you, the payer must withhold 20 percent of it for taxes. You can avoid the withholding by having the payer transfer the funds directly to the trustee/custodian of your IRA.

A rollover must be made within 60 days of receipt of the distribution. You cannot deduct the rollover contribution, but you must report it on your tax return. Rollovers not completed within 60 days are treated as taxable distributions. On top of the regular income tax, you may also have to pay a 10 percent excise tax penalty on the premature distribution and another 15 percent excise tax penalty on an excess distribution.

A rollover from one IRA to another enables you to change your investment strategy and enhance your rate of return. This type of rollover may be made only once a year. This rule applies separately to each IRA owned. If property other than cash is received, that same property must be rolled over. Except for an IRA received by a surviving spouse, an inherited IRA cannot be rolled over into, or receive a rollover from, another IRA.

Withdrawals/distributions from an IRA. There are rules limiting the withdrawal and use of your IRA assets. Violation of the rules generally results in taxation of the withdrawn amount, plus a penalty equal to 10 percent of the withdrawal. Generally, you violate the rules if you withdraw assets from your IRA before you reach the age of 59.5. However, there are special exceptions that allow you to take distributions from a regular (non-Roth) IRA if the amounts are used to pay medical expenses in excess of 7.5 percent of adjusted gross income or if the distributions are used by certain unemployed, formerly unemployed, or self-employed individuals to pay health insurance premiums. Beginning in 1998, you can take a penalty-free withdrawal from any type of IRA to purchase your first home.

For IRAs that are not Roth IRAs, you can also take penalty-free withdrawals before age 59.5 to pay certain education expenses for yourself or your dependents, or if you set up a schedule to take "substantially equal" periodic payments for the rest of your life. You must begin withdrawing the balance from any IRA that is not a Roth IRA by April 1st of the year following the year in which you reach age 70.5 or the year in which you retire.

A withdrawal from your IRA, net of the portion representing return of any nondeductible contributions, is includible in your ordinary income.

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