Smart Retirement Savings

What Is IRA?

IRA is widely used in retirement planning, and here are the IRA basics you should know.

An IRA is an Individual Retirement Account, and provides either a tax-deferred or tax-free way of saving for retirement. There are many different types of accounts within the world of IRAs, depending on the financial goals and situations of each individual, though traditional and Roth IRAs are the most common choices.

A traditional IRA allows tax-deductible contributions of up to $4,000 per year, or more if you are over age 50. Whatever you contribute towards your IRA comes off your yearly income, thereby reducing total tax liability. However, once the money in an IRA is withdrawn, it is subject to standard income taxes and an additional 10% penalty if withdrawn before the age of 59 1/2. An exception is made if the money is used for purchasing a house or to cover approved higher education costs. Standard income tax still applies, but the ten percent penalty is waived. This provides a great investment tool with flexibility for important purchases.

Roth IRAs were created in 1997 to help middle-class Americans. These IRAs are not tax-deductible, but provide even greater flexibility than traditional IRAs. Contributions to the account can be withdrawn at any time without being subject to penalty or tax, though interest earned in the account is. After five years, both contributions and earnings in the account can be withdrawn without penalty or taxation. The same benefits concerning education and housing also apply as with the traditional IRA.