What is an IRA? IRA stands for Individual Retirement Account. An IRA is a type of savings account which is US based and its purpose is to help people save for their retirement. Investing in an IRA brings with it some advantages tax benefits. You should take into account your individual circumstances when choosing an IRA as there are many different types of accounts which can make it a confusing decision to make.
Traditional and Roth are the two main types of IRA’s. There are also Simple IRA accounts and something called a SEP IRA. The money deposited into an IRA is tax free or tax deferred, this is common to all types of IRA’s. Taxes are paid on the money either when it is withdrawn during retirement or before it is deposited into the account.
The Traditional IRA has an annual limit for deposits and this limit is usually increased for people over the age of fifty. In this IRA, the depositor does not have to pay taxes when they deposit funds, only when they withdraw. An additional penalty of up to ten percent may apply if any money is taken out prior to the depositor reaching the age of sixty. This number is applied on top of the standard income tax; however this fee may be waived if the money is being used to pay for higher education or to help finance the purchase of a home.
The Roth IRA is much more flexible than the Traditional IRA. Roth IRA money is not tax deductible however you will not owe income tax on any withdrawals. If the money has been in this account for at least five years, then you can make early withdrawals without being penalized. The Roth IRA is can also benefit you financially as usually it is less expensive to pay income taxes when you earn the money as opposed to waiting until you retire. As US tax rates tend to fluctuate from decade to decade, it may be wiser to pay the taxes upfront and “lock in” the rate so to speak rather than take a gamble that the tax rates will stay the same or go lower.
The SEP IRA stands for Simplified Employee Pension Investment Retirement Account. This is a situation where the employer pays into the account for the employee. Companies sometimes prefer this approach because the administration costs tend to be lower than a traditional pension plan.
The last IRA we will discuss is the SIMPLE IRA. This is an IRA where both the employee and the employer make contributions. This type of IRA is usually utilized by companies that only have a few employees.
Investing in an IRA is a wise and prudent investment. One must take into account their current as well as future financial situation and try to anticipate how and when they would use the money. It can be confusing when comparing plans, so it may be best to check with a financial planner to help you make the most appropriate decision for you and your family.