An individual retirement arrangement is commonly referred to as an Individual Retirement Account (IRA) and is a trust or custodial account established within the boundaries of the United States. It is for the exclusive benefit of the individual and their beneficiaries. The IRS notes that the account is created by a written document and must meet all of the following requirements:
- The trustee or custodian must be a bank, a federally insured credit union, a savings and loan association, or an entity approved by the IRS to act as trustee or custodian.
- The trustee or custodian generally cannot accept contributions of more than the deductible amount for the year. However, rollover contributions and employer contributions to a simplified employee pension (SEP) can be more than this amount.
- Contributions, except for rollover contributions, must be in cash.
- You must have a nonforfeitable right to the amount at all times.
- Money in your account cannot be used to buy a life insurance policy.
- Assets in your account cannot be combined with other property, except in a common trust fund or common investment fund.
- You must start receiving distributions by April 1 of the year following the year in which you reach age 70½.
Related to self-direction, the IRA is held through a custodian, and it is the custodian who identifies what investments are available to the IRA account owner. It is as simple as if the custodian is a bank, you may only have options like CDs. If at a brokerage firm, you will have stocks, bonds and mutual funds. If, however, the IRA is held through an IRS-approved IRA custodian which permits alternative assets, then your IRA will be able to invest in any non-traditional assets permitted. Typically, a self-directed IRA custodian will permit the IRA to invest in any asset not specifically prohibited by IRS Prohibited Transaction regulations.
Traditional IRA Contributions — What differentiates a Traditional IRA from, for example, a Roth IRA, is the tax treatment of contributions made to the plan. You see, IRS rules on Prohibited Transactions, transfers, rollovers, contribution amounts, etc. are the exact same for both. However, with Traditional IRA contributions, the benefit to the account owner is that the contributions can be tax-deductible; therefore, the contribution is not considered to be taxable income to the IRA account owner. Any and all gains from investments are tax-deferred and no taxes are due on the Traditional IRA until such time when distributions from the plan are taken.