Individual Retirement Account Basics

An individual retirement account or IRA is a tax favored account designed to help individuals save for their retirement. There are many different types of individual retirement accounts; however, the two most common types are traditional IRAs, simply referred to as IRAs and Roth IRAs.

The basics of traditional IRAs

You can open your IRA account through a brokerage or investment firm as long as you have a source of income and are not older than 701/2. Contributions into your IRA can be invested in any way that you choose. This can be in the form of stocks, mutual funds, bonds and other types of equities like precious metals.

IRAs and taxes

Contributions in an IRA are tax deferred, meaning that your investment will not be taxed as long as the money is held in the account. Once you take the money out, you will be required to pay taxes on the contributions and earnings. However, your contributions may be subjected to taxation if you have another retirement account through work. The idea is that in retirement, you will have a much lower income, thus the taxes you pay will be far less than what you would pay during your working years. You can withdraw money from your IRA account at any time; however, if you do this before the retirement age (currently at least 591/2), then you will not only be required to pay taxes but could also face an early withdrawal penalty of up to 10% of your savings. There are exceptions to early withdrawal penalty though.

IRA contribution limits

There are limits to how much you can contribute to your IRA every year. These limits are adjusted from time to time with inflation. Additionally, there are catch-up contributions available to investors above 50. These catch up contributions are designed to help accelerate savings growth in the pre-retirement years. Investors have until the tax filing deadline to make contributions to their IRA accounts. For instance, you can make your 2014 contributions any time before April 15, 2015.

An individual retirement account is basically a savings account with tons of restrictions. The main advantage of this saving plan is that it allows you to defer paying taxes on your earnings until you get to withdraw the money. The main drawback, on the other hand, is that tax laws impose stiff penalties should you opt to withdraw your money before turning 59.5 years old.

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