If you're like the majority of people - including financial advisors and accountants - here's something you probably don't know. IRA does NOT technically stand for individual retirement account. Instead, the IRA stands for Individual Retirement Arrangement. If you don't believe me, just check out IRS Publication 590. It's right there on the cover.
With that said, let's discuss what each of these three little words means in a little more detail.
Individual – Let’s think about this one for a second. An individual is a person, and for that matter, a single person. Therefore, it would stand to reason that only a person can be the owner of an IRA.
During your lifetime, you cannot gift your IRA to any other person or any other entity. You are the individual in IRA. It’s yours. If you “gift your IRA” to another person or you “move your IRA” into a trust, any portion gifted/moved is no longer an IRA and will be taxable to you.
Retirement – This main point here is pretty simple. IRAs are meant to be retirement accounts. This was Congress’ intention when they passed the laws creating IRAs and it should be your intention too.
Many Americans today are woefully under-prepared for the financial burdens they will face in retirement. While IRA contribution limits prevent you from contributing too much to an IRA each year, the relatively small contribution amounts can, over time, add up to big sums if left alone thanks to the power of compounding.
If the power of compounding isn’t enough of an incentive to keep you from touching your IRA funds early in life, remember, any IRA distributions taken prior to age 59 ½ are subject to a 10% penalty unless one of several exceptions applies.
Arrangement – What’s an arrangement? Basically an agreement between two parties, right? Well, that’s the case here. The arrangement in this case is between an IRA owner and their IRA custodian. If you have an IRA, it must be held with a qualified custodian.
There are many rules that are the same regardless of what custodian you choose to house your IRA, but custodians can, in many cases, have different rules for different aspects of your account. Make sure you know the rules at your custodian because “an arrangement” is just another way to say “a deal.” And as we all know, once you sign on the dotted line, a deal is a deal.
- By Jeff Levine and Jared Trexler