What is an IRA? An IRA account is an Individual Retirement Account. It differs from a 401(k) plan in that the money placed in an IRA is not taxed, or is taxed at a lower rate, so you hang on to more of your saved income. By investing the money (there are several investment options that will be discussed), you can actually add to it, all the while still not paying taxes on your savings. You could even double your money with the right financial decisions. An IRA account essentially gives you more financial freedom while it allows you to earn more money.
There are two main kinds of IRAs: Traditional IRA’s and Roth IRA’s.
Traditional IRAs are set up through brokerage firms or banks, by investing in CD’s (certificates of deposit), mutual funds or stocks. You can even buy gold coins and previous metals with your IRA funds. Whatever money you earn in a Traditional IRA is tax deferred until it is withdrawn.
In a Roth IRA you also invest your money in a similar fashion, but the money is not taxed when you retire. Typically, you pay some initial tax when you first set up a Roth IRA. Also with a ROTH IRA, you can leave your money in your account for as long as you want without penalty, whereas traditional IRAs that are not drawn on by 70 1/2 are subject to penalty.
Most people with an Individual Retirement Account will choose to work with a qualified financial advisor to determine where to place their investments.
Tax Implications of IRA Accounts
There are significant tax implications of an IRA account. As with a 410(k), the IRS has set up certain tax rules that apply to both contributions and withdrawals. There is a 10% tax penalty for early withdrawal from an IRA. For traditional IRA’s there are also higher tax penalties if you don’t begin withdrawal by age 70. At this point, your withdrawals will be taxed at the (usually lower) rate. If you choose a Roth IRA, you can start withdrawing your earnings at 59 ½. You can also continue to put money into your Roth IRA after age 70.
The IRS has implemented tax laws for IRA withdrawal. They have to make their money too, right? So if you have a traditional IRA, you are obligated to take money out each year after you turn 70 1/2, or pay hefty taxes (up to 50%).
For laws on IRA account and state taxes, each state will have its own rules. You can choose to not withhold state taxes if you have a Roth IRA.
The bottom line with IRAs is: be educated. Talk to an advisor to make sure that you understand all state and federal tax laws as they apply to your Individual Retirement Account.
Why You Should Get an IRA Account
If your current employer doesn’t sponsor a 401(k) plan, or the maximum annual contribution in your plan does not seem high enough, an IRA might be the right choice for your retirement. As mentioned above, the money you put into a Roth IRA account is tax-free. These versatile accounts allow you more freedom in investment.
Why is it important to start an IRA account? Some experts purport that we will need up to 85% of our income in retirement. For those concerned that a 401(k) may not cover this (as there is a yearly limit on 401k contributions), an IRA is an intelligent retirement option to add to your 401(k) contributions. If you are well educated and smart with your money, you could easily double your investments before retirement.
Like 401k accounts, IRA accounts also have limits. For 2012, the limit for contributing to IRA accounts is $5,000 if you are under 50, and $6,000 if you are 50 or over.