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An IRA is another way to save for retirement. IRA stands for individual retirement account, and it’s a type of savings account that offers tax breaks for putting money towards retirement. If your employer doesn’t offer a retirement savings plan, an IRA may be right for you.
How Do IRAs Work
An IRA however, is not just a normal savings account. It’s an investment account. The account holder adds money to the account over time, like a 401k and that money is used to purchase investments like stocks, mutual funds and bonds. All of the money is held in the IRA account preferably until retirement.
Much like a 401k, there are contribution limits for each year. The money that you invest into an IRA account can grow on a tax-deferred basis. And you can start making penalty-free withdrawals as early as 59.5. There are other benefits such as being able to invest more as you get older and being able to withdraw from the account before retirement to pay for certain expenses with a penalty.
Two Main Type of IRAs
There are two main types IRA accounts. The main differences have to do with tax breaks.
With a Traditional IRA, the money you invest may be deductible from your taxes for the year. If you think your current tax rate is higher than the one you’ll have in retirement, this may be the better choice. The point of this is to choose the tax break that benefits you.
With a Roth IRA, investments are made with post-tax dollars. This means you can’t deduct them from your taxable income. This is beneficial because the money collected in retirement will not be taxed. If you think you may move up into a higher tax bracket by retirement, this may be the better option for you.
However, not everyone is eligible for both account types. Roth IRA eligibility is based on income. You may also withdraw money at any time without a penalty as long as it is limited to the principal investment and not the investment gains. Anyone can invest in a traditional IRA, but the amount you can deduct and when you can may be limited by income level and age.
Why Choose an IRA
If your employer does not offer a retirement savings plan and you would like to maximize your retirement plan, or if you’d like to cushion your retirement plan with extra income, an IRA may be the best option for you. Once you decide on an IRA, invest in it like any other retirement account, watch your money grow, and retire in style.