What Is An IRA?

It’s never too early to start thinking about retirement. An IRA, or individual retirement account, is a tax-advantaged financial tool that helps any person save for their retirement. Learn how it works and which type is best for you.

How It Works

Investing for the future you is a sound financial decision, and an IRA can help with that. Using your earned income, you can open and contribute to an IRA, even if you have a 401k through your employer. How you invest, either in stocks, bonds, exchange-traded funds, or other assets, are factors in how your balance will grow over time. The only thing to be mindful of when it comes to IRAs are the limitations and withdrawal rules. Every IRA has a contribution limit that will incur penalties if you contribute too much. In addition, you may face a penalty and tax bill if you withdraw your money too early before you turn 59 1/2.

Different Types

Traditional IRA. This is the most popular IRA option. Most people can qualify, and your contributions are tax-deferred. So, if you put $3,000 into your IRA, your taxable income for the year decreases by that amount. Once you’ve retired and started to withdraw, that money is taxed at your ordinary income tax rate for the year.

Roth IRA Why pay for taxes later, when you can pay for them now? Roth IRAs are opposite to traditional IRAs. Roth IRA distributions are tax-free, yet the contributions use after tax dollars and aren’t tax deductible. This means when you withdraw any funds, you don’t have to pay any taxes on your investment gains.

SEP IRA This type of IRA is for self-employed individuals, like independent contractors, freelancers, and small business owners. Business owners can deduct contributions on behalf of their employees following traditional IRA tax rules. However, employees are not able to contribute to their own IRA, and the IRS considers any withdrawals as income.

SIMPLE IRA Similar to the SEP IRA, the SIMPLE IRA is intended for small business owners and follows traditional IRA tax rules. The difference between the two is SIMPLE IRAs let employees make their own contributions. The employer is required to also contribute funds to their employees’ accounts. All contributions are tax deductible.

Coverdell IRA This is a unique IRA that is not necessarily meant for retirement. Instead, this IRA can help pay for a child’s higher education. All contributions are made with after tax dollars, and withdrawals are tax-free for qualified educational expenses.

Get a jump start on your retirement by opening an IRA today. Learn more.