There are several types of tax-advantaged Individual Retirement Accounts (IRAs) that you can use to save for your future retirement. Some are for individuals and others can be used if you’re self-employed or have a small business. You must have some amount of taxable earned income—from a job, business, alimony, or from your spouse if you file taxes jointly—to be eligible to contribute to an IRA.

Many people get confused by thinking that an IRA is an investment. An IRA is simply an account that gives your investments certain advantages while they’re owned inside the account.

For the purpose of this article, we shall discuss 2 types of IRAs. Traditional IRA & Roth IRA.

A  traditional IRA is the most basic type for individuals. If you have earned income and are younger than age 70½, you’re eligible to contribute to a traditional IRA. For 2011 and 2012 you can contribute an amount equal to your taxable income up to $5,000 or up to $6,000 if you’re age 50 or older.

The major advantage of a traditional IRA is that your contributions are tax-deductible, which means they reduce the amount of tax you have to pay. Here’s an example: If you contribute $4,000 to a traditional IRA and your average tax rate is 25%, you cut your tax bill by $1,000 ($4,000 x 0.25 = $1,000).

A traditional IRA allows you to defer tax until you make withdrawals at some future date. You can begin taking distributions from a traditional IRA once you reach the official retirement age of 59½, and you must take minimum distributions after you turn 70½. In general, early withdrawals are subject to income tax plus a 10% penalty.

Roth IRAs are not tax deductible. In other words, you must pay tax on Roth contributions upfront, in the current year—but that’s where your taxation ends. When you retire and take distributions they’re completely tax free. There’s no requirement to take minimum distributions at age 70½, as there is with a traditional IRA. The funds in a Roth IRA can sit idle forever, which makes it a nice way to pass money to your children and grandchildren.

If you decide to take a withdrawal from a Roth IRA, you can tap your contributions at any time tax free. However, earnings in the account are subject to income tax plus an additional 10% penalty if you’re younger than age of 59½.

Just like with a traditional IRA, as long as you have earned income you can contribute up to $5,000 or up to $6,000 if you’re age 50 or older. However, when your income exceeds annual limits for your tax filing status, you become ineligible to contribute to a Roth IRA.

Generally, if you have earned income from a job or alimony, you can establish a Traditional IRA before the tax year when you reach age 70½. Contributions can be fully or partially tax-deductible depending on your individual circumstances. Contributions are fully deductible if you do not participate in an employer-sponsored retirement plan. (See below for other limits on deductibility.) Beginning in the calendar year in which you reach age 70½, you can no longer make contributions to a Traditional IRA.

You may have a Traditional IRA even if you are covered by a qualified pension or other retirement plan e.g. 401K but you may be limited in the amount of the contributions that are tax-deductible. To be covered means that money is contributed to your account, whether or not you contribute yourself.

 When can I contribute?

You can open an IRA, or contribute to an existing IRA, at any time from January 1 of a given year up to the tax filing day of the following year. The tax filing day is the absolute deadline, even if you have received an extension beyond that date for filing your tax return. For tax year 2010, you can open or make contributions to a Traditional IRA until April 18, 2011.

You can currently contribute up to $5,000 or 100% of your taxable compensation* for the year, whichever is less. Alimony is counted as earned income, but pension and investment income are not. The $5,000 limit applies to total contributions to all IRAs (Traditional and Roth).

If you or your spouse do not participate in a corporate, government, Keogh, or other retirement plan, then your Traditional IRA contribution is generally fully tax-deductible, whatever your income level. (Contributions to Roth IRAs are not deductible.)

If you do participate in an employer’s qualified retirement plan on any day during the tax year, you can still contribute to a Traditional IRA, but the deductibility of your contributions declines to zero between certain modified adjusted gross income (“MAGI”)* ranges.

 What if I don’t have $5,000?

The law doesn’t require a minimum contribution

If both of you have earned income, you can establish separate Traditional IRAs and can contribute up to a total of $10,000 annually (up to $5,000 each). If your combined income is less than $10,000, the combined IRA contributions are limited to 100% of your income.

If one spouse has less than $5,000 of earned income, a Traditional IRA can be established based on the income of the higher-earning spouse. In this case, the combined total contributed may be up to $10,000 annually, divided between the two accounts in any way desired, so long as neither account receives more than $5,000.

Beginning at age 59½, you can withdraw money from your IRA as desired without penalty. You can do this whether or not you are still employed. You may be taxed on these withdrawals.

Withdrawals before age 59½are called “early distributions,” and are subject to a penalty of 10%, in addition to any tax that may be due. There are several exceptions to the penalty on early distributions:

• Unreimbursed medical expenses >7.5% of your adjusted gross income.
• Health insurance, if unemployed and distributions are not more than the cost of your medical insurance.
• You are disabled.
• Qualified education expenses, and the distributions are not more than these expenses.
• You use the distributions to buy, build, or rebuild a first home.
• You are the beneficiaryof a deceased IRA owner.
• You are receiving distributions in the form of an annuity.
• The distribution is due to an IRS levy of the qualified plan.
• You withdraw money in a series of “substantially equal period payments” based on your life expectancy.

No, you have complete flexibility between ages 59½ and 70½.

Yes. By April 1 following the year in which you reach age 70½, and by December 31 thereafter, you must begin to withdraw a certain minimum amount annually. If by the applicable deadline the required minimum amount is not distributed, the amount not taken is subject to a 50% IRS excise tax. This tax may be waived by the IRS upon submission of a written request.