Individual Retirement Account – What is an Individual Retirement Account?

What is an Individual Retirement Account?

Individual Retirement Account (IRA), is designed to help individuals save for retirement and take advantage of tax benefits. IRAs come in two forms: Traditional and Roth IRA.

Individual Retirement Account - What is an Individual Retirement Account?

What is the Difference Between Traditional and Roth IRA?

The major difference between a Traditional IRA and Roth is in the type of. Tax benefit that each of them provides. For Roth IRAs, it offers tax-free growth potential, where investment. Earnings are distributed tax-free in retirement if you happen to meet a five-year waiting period. And you are at least 59 ½ years of age, or as a result of your death, disability, or using the first time home buyer exception. Now contributions to a Roth IRA are made with after-tax dollars, thus there is no tax deduction regardless of income.

Traditional IRAs on the other hand, offer tax-deferred growth potential. You are required to pay taxes on any investment earnings until you withdraw or ‘distribute’ the money from your account, presumably in retirement. Also, depending on your income, your contribution may be tax-deductible. With deferring tax, a potentially greater accumulation of wealth is allowed.

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There are also SEP-IRA and SIMPLE IRA

SEP IRA

The SEP-IRA can be set up by self-employed individuals, like independent contractors, freelancers, and small-business owners. SEP means ‘Simplified employee pension’. A SEP IRA conforms to the same taxation rules for withdrawals as a traditional IRA.

Business owners who happen to set up SEP IRAs for their employees can deduct the contributions. Howbeit, company employees are not permitted to contribute to their accounts. And the IRS taxes their withdrawals as income.

SIMPLE IRA

The SIMPLE IRA here means ‘Saving incentive match plan for employees’. SIMPLE IRA is also targeted at small businesses and self-employed people. This module also follows the same taxation rules for withdrawals as a traditional IRA. With SIMPLE IRA, employees are allowed to make contributions to their accounts, and the employer is required to make contributions also. Here, all the contributions are tax-deductible, which potentially pushes the business or employee into a lower tax bracket.

How to Open an IRA

To open an IRA, the first step will be to choose the option that fits your individual investment style. It is essential to note that application instructions differ depending on the type of investing style you choose.

  • Firstly, if you think choosing investment for yourself is the best, then an online brokerage would be the best option for you.
  • Secondly, if you want to get help in managing your retirement account, then you should consider a Robo-advisor, which is a service that selects low cost and risk-appropriate investments for you.
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After you have chosen a provider, the online signup process is quite simple. You will be required to provide some general information, including Social Security number, birth date, contact information as well as employment details.

Why Invest in an IRA?

Investing in an IRA is quite important, because you will be needing income during retirement, and having money in an IRA, can make that happen. Investing in an IRA can also come in handy in helping you manage your tax bill, and offer you access to a wider range of investment choices.

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