Individual Retirement Account (IRA) Definition and Legal Meaning

On this page, you'll find the legal definition and meaning of Individual Retirement Account (IRA), written in plain English, along with examples of how it is used.

What is Individual Retirement Account (IRA)?

“A personal savings plan that provides tax advantages to save and invest for retirement. Depending upon individual circumstances such as participation in employee-sponsored plans such as a 401(k) plan, contributions can be tax-deductible. Until the earnings are withdrawn, a traditional IRA will not be taxed. In a Roth IRA, withdrawals are tax-free as long as the requirements are met. Tax penalties may be incurred for funds withdrawn before age 59 1/2. An individual’s IRA contributions cannot exceed $3000 (as of tax year 2004).

History and Meaning of Individual Retirement Account (IRA)

Individual Retirement Account (IRA) was introduced in 1974 under the Employee Retirement Income Security Act during the administration of President Gerald Ford. The purpose of IRA was to provide a tax-advantaged retirement savings account for individuals, separate from employer-sponsored plans like 401(k)s. Anyone with earned income and under the age of 70 ½ can open an IRA account.

There are two types of IRA: traditional IRA and Roth IRA. Traditional IRA contributions are tax-deductible, but earnings are taxed when withdrawn during retirement. On the other hand, Roth IRA contributions are made after-tax and are not tax-deductible, but qualified withdrawals are tax-free. In both types of IRAs, early withdrawals before the age of 59 ½ may result in a penalty.

Examples of Individual Retirement Account (IRA)

  1. Jake opened an IRA account with his financial institution to save for his retirement.
  2. Lina makes annual contributions of $6,000 to her Roth IRA account to grow her retirement savings.
  3. James has a traditional IRA, and he plans to retire in a few years. He will start taking distributions from his account at that time.
  4. Karen withdrew money from her IRA account before the age of 59 1/2, and she had to pay a 10% penalty fee.

Legal Terms Similar to Individual Retirement Account (IRA)

  1. 401(k) plan - Employer-sponsored retirement savings plan where employees can make contributions directly from their paychecks.
  2. 403(b) plan - Similar to the 401(k) plan, but it is for employees of non-profit organizations and public schools, and the contributions are made from pre-tax income.
  3. Pension plan - A retirement savings plan set up and maintained by an employer, where retirement income is based on years of service and salary.