What is an IRA? The acronym IRA stands for Individual Retirement Account. It is a type of savings account, available in the United States, that is designed to allow people to save for retirement. There are tax benefits associated with paying into this kind of account. Other countries have similar schemes in place.
The term IRA covers many different types of accounts. Choosing the correct one means taking your individual circumstances into account. It can be a confusing decision to have to make.
The two main types of IRA are traditional and Roth IRAs, although there are also SEP IRAs, SIMPLE IRA accounts and self directed IRAs.
The feature that is common to all IRAs is that payments into the account are tax free or tax deferred. Income taxes are either paid on the money when it is withdrawn during retirement, or before it is paid into the account, but not both.
A traditional IRA is an account that an individual can pay money into to save for their retirement, up to a certain yearly limit. The limit is increased for people who are over the age of 50. The depositor does not have to pay tax on any money that they put into this type of account, but they do have to pay income tax on anything they withdraw. If money is withdrawn before age 60, an additional penalty of 10% must be paid on top of the standard income tax. The penalty is waived if the money is to be used to pay for the purchase of a home or to pay for higher education.
A Roth IRA is more flexible. The money deposited in a Roth IRA is not tax deductible. However, withdrawals are not subject to income tax. There is no penalty for early withdrawals from this type of account, providing the money has been in the account for at least five years. This type of account gives a lot more flexibility to savers. It can also be financially beneficial because it often works out less expensive to pay income taxes at the time of earning the money rather than during retirement.
There are other types of retirement account, such as a SEP IRA. SEP IRA is an acronym that stands for Simplified Employee Pension Investment Retirement Account. This is an account that an employer pays into for the employee. This can be a better option than a pension plan held in the name of the company because administration costs are often lower.
There is also the option of a SIMPLE IRA, which both the employer and the employee can pay into. This type of account is best suited to people working for companies with only a few employees.
Choosing the correct IRA can be a difficult process. You have to take into account your current and future financial situations, and consider how much flexibility you are likely to need. If choosing the right account is difficult for you, you could enlist the services of a professional financial planner to help you.
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