You’re probably asking yourself what is an Individual Retirement Account (IRA), correct? Well, we’ve got quite the guide for you today.
An Individual Retirement Account (IRA) can be defined as either a tax-deferred savings account or a tax-free retirement savings account, the main purpose of which is to offer valuable tax benefits for people who want to save money for when they get retired.
There are four main types of IRAs that financial institutions offer:
- Traditional IRA
- Roth IRA
- SEP IRA
- SIMPLE IRA
The traditional and Roth IRAs are the most common types of IRAs that individual taxpayers use, whereas the SEP and SIMPLE IRAs are mostly used by owners of small businesses and by self-employed individuals.
However, other types of IRAs are also used such as, the backdoor Roth, spousal, inherited, self-directed, and rollover IRAs, all of which have different advantages. In order to decide which IRA to set up, you must compare the types of IRAs and then choose one that best suits your needs.
How does an IRA work?
As compared to the tax-advantaged 401(k) retirement account that is usually offered to individuals by their employers, an IRA can easily be opened by individuals themselves. Both accounts help save individuals for retirement but with an IRA, an individual can have access to a diverse range of investments.
What is an Individual Retirement Account (IRA)?
As compared to the tax-advantaged 401(k) retirement account that is usually offered to individuals by their employers, an IRA can easily be opened by individuals themselves. Both accounts help save individuals for retirement but with an IRA, an individual can have access to a diverse range of investments.
For opening an IRA, individuals can simply go to a broker or a bank. However, the relevant financial institution must be approved by the Internal Revenue Service (IRS) for offering such tax-free retirement savings accounts, for example, banks, brokerage houses, and savings and loan associations. If you open an IRA at a financial institution, you will be offered Certificates of Deposits and savings accounts by the bank, whereas if you open one at a brokerage house, you will have an opportunity of investing in bonds, stocks, and other financial assets, which is a smart financial move if you’re saving for retirement, because long-term accounts will typically yield higher investment returns. Depending on your investment in the IRA, you will either earn money on your investment or even lose money.
You can also contribute your earned income to your IRA as it is a smart opportunity of building up savings and wealth. However, your contributions must be in accordance with the IRA rules, thus, social security benefits or child support will not be counted as your earned income. There are also limitations as to how much money you can contribute to your IRA per year. For the traditional and Roth IRAs, you can add around $6,000 per year, and if you’re 50 or older, you can add up to $7,000. However, there are no limitations as to where you can contribute your money. Therefore, you can contribute your earned income to a 401(k), the IRA, or any other workplace savings plan, wherever you feel comfortable and where you earn acceptable returns.
You can withdraw your money from an IRA anytime, but since IRAs are retirement accounts, there applies a withdrawal penalty of 10% along with a tax bill if you withdraw your money before 59.5 years of age, unless you meet an exception, in which case you can withdraw your money earlier than expected, tax-free, and without any penalty.
How to start an IRA?
As mentioned above, in order to start an IRA, you must compare all the different types of IRAs and then decide on one that best suits your needs. For example, the traditional and Roth IRAs can be opened up by individual taxpayers themselves but with the SEP and SIMPLE IRAs, you will need your employer to set up that plan for you. You cannot set the SEP and SIMPLE IRAs unless you’re self-employed. After comparison, choose the investments that you want for your IRA, basing your choices on the number of years you have till you retire, and the amount of risk that you’re willing to take, and then decide whether you want an all-in-one portfolio or a customized one. Your IRA’s rate of return will then be based on the type of investments that you choose. You can also get help from a service known as the robo-advisor that can select low-cost and risk-appropriate investments for you.
After careful consideration of the type of IRA and the type of investments, you can simply open up an IRA online where you will be asked to provide some personal information such as your birthdate, your social security number, contact information, employment details, etc. and get started with as little as $1,000.
