Traditional and SEP IRAs: The Basics

How it works: An IRA, or individual retirement account, is a savings account with major tax breaks. In most cases, IRAs are accounts that you open personally, as opposed to a 401(k) account, which is sponsored by an employer. Inside your IRA account, you can keep various investments such as stocks, bonds and mutual funds. A SEP (Simplified Employee Pension) IRA is a type of IRA that is available to small-business owners and self-employed people, and it offers higher contribution limits than a traditional IRA.

Who's eligible: Anyone who is younger than 70½ and has earned income can open an IRA. Any business owner with one or more employees or anyone with income from freelance or contract work is eligible to open a SEP IRA.

Why? When you deposit funds into an IRA, it is a pre-tax contribution, so the money grows tax-deferred. With your IRA, you can invest in practically any asset.

Why not? When you reach age 70½, you're required to begin taking mandatory withdrawals from your IRA, and those withdrawals are taxable. In addition, there's a 10 percent penalty on early withdrawals.

Playing catch-up: If you are 50 or older before the end of 2011, the maximum contribution to a traditional IRA or SEP IRA is the smaller of $6,000 or the amount of your taxable compensation for 2011. This limit can be split between a traditional IRA and a SEP IRA, but the combined limit is $6,000. The maximum deductible contribution to a traditional IRA and the maximum contribution to a SEP IRA may be reduced depending on your modified adjusted gross income.

2012 changes: IRA contribution limits have not changed since 2011, remaining at $5,000 for people under 50 and $6,000 for those age 50 and older. Only workers who earn below certain income levels get a tax break for contributing to a traditional IRA, but those income limits have been relaxed slightly. This year, the tax deduction for traditional IRA contributions no longer applies for singles and heads of households with workplace retirement plans who have modified adjusted gross incomes between $58,000 and $68,000 ($92,000 to $112,000 for couples), which is up $2,000 from 2011. For IRA owners who do not have an employer-sponsored retirement plan, the deduction is phased out if the couple's income is between $173,000 and $183,000, up $4,000 from last year.

The fine print: IRAs and SEP IRAs both require minimum distributions once the account owner reaches the age of 70½. That means you must begin taking money out of the account, and the minimum you must withdraw is calculated according to the appropriate IRS table. The tables are published in IRS Publication 590, Individual Retirement Arrangements (IRAs).

Tools:
• IRA Minimum Distribution Calculator

Resources: Roth IRA and Traditional IRA Comparison Chart

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