An IRA Primer

Here's everything you need to know about IRAs.

Higher-education expenses must be for you or your family members. Expenses include tuition, fees, room and board (if the student is enrolled at least part time), books and supplies.

Limit is $10,000 over your lifetime. To qualify, you must not have owned a home for the past two years. This exemption can be used to buy, build or rebuild a first home for you, your parents, your children or your grandchildren. If you use only part of your exemption, you can use the remainder another time.

*Exceptions include: (a) if your medical expenses exceed 7.5% of your AGI; (b) if you annuitize your withdrawals; (c) if you collect federal unemployment benefits for 12 consecutive weeks and use IRA withdrawals to pay for health insurance.

*Simplified Employee Pension Plan.
**Savings Incentive Match Plan for Employees.

What's AGI?
Your adjusted gross income is the number at the bottom on page 1 of your 1040. Specifically, it's your gross income minus so-called above-the-line deductions. These are deductible IRA contributions (as well as deductible SEP, SIMPLE and Keogh contributions), the student-loan-interest deduction, deductible contributions to medical savings accounts, the moving-expense deduction, half of the self-employment tax paid by self-employed individuals, the deduction for health-insurance premiums paid by self-employed persons, the deduction for higher education expenses, penalties on the early withdrawal of savings and deductible alimony payments, and legal fees for certain litigation settlements and awards. AGI does not include the standard deduction or itemized deductions. However, the key figure for purposes of calculating eligibility for deductible IRA and Roth contributions is actually "modified" adjusted gross income, or MAGI. This is your AGI (as explained) with the following adjustments: (1) add back deductible IRA contributions, (2) add back the student-loan-interest deduction, (3) add back the deduction for higher education costs, (4) add back U.S. Savings Bond interest excluded from taxation because it's used to pay higher-education expenses, (5) add back certain employer adoption-assistance payments excluded from taxation, (6) add back certain foreign earned-income and foreign-housing-cost reimbursements excluded from taxation, and (7) the deduction for domestic production activities. For simplicity's sake, we have used AGI throughout this article when we really mean MAGI. However, for most people, the MAGI number will simply equal AGI before taking into account deductible IRA contributions. A fair number of people will then have to consider the add-backs for items 2, 3 and 4 above. Fewer will be affected by the add-backs for items 5, 6 and 7 above.

What's Earned Income?
This is income that you have actually worked for -- like salary or self-employment income. It also includes any taxable alimony payments you receive. It does not, however, include investment income such as interest, dividends or profits from sales. It also does not include earnings from pensions or annuities.

Tax-Free 60-Day Withdrawals
IRA funds can be withdrawn tax-free and penalty-free for 60 days, provided the full amount is returned to the account within this time period. The money can be returned to the same account or to a new IRA. In effect, this is like being able to take a short-term, interest-free loan from your IRA. However, you can do this just once in any 12-month period. If you don't replace the money within 60 days, you will owe income tax on the withdrawal and generally a 10% penalty if you are under age 59 1/2.