What You Need To Know About An IRA Investment

By Julie Bawden-Davis. May 7th 2016

Saving for retirement helps ensure that your golden years are indeed golden. One of the best ways to stash cash for retirement is opening and funding an individual retirement account. Commonly known as an IRA, this savings vehicle offers you a relatively safe place to invest your nest egg.

What Is An IRA?

An IRA is a retirement account into which you deposit stocks, bonds, mutual funds and other assets. These assets are then allowed to grow on a tax deferred or tax free basis. Ideally, the investments in your IRA will grow in value over time accruing a substantial amount of money for your retirement years. You can open an IRA in addition to other types of retirement accounts, such as employer-sponsored 401(k)s.

Several types of IRA accounts exist, including traditional IRAs, Roth IRAs, SEP IRAs and SIMPLE IRAs. Traditional and Roth IRAs are personal retirement accounts that offer different tax advantages. The money deposited into a traditional IRA is not taxed at the time of deposit, but is taxed when you remove the money. Roth IRA deposits are taxed when you make the deposit, but you pay no taxes when you withdraw the money. SEP IRAs are for self-employed individuals and SIMPLE IRAs are designed for small employers to offer their employees.

How IRAs Work

You are eligible to open and contribute to a personal IRA if you or your spouse (if you filed jointly) received taxable income during the year, and you were not age 70 ½ by the end of the year. Allowable income for contribution purposes includes wages and salaries, commissions, self-employment income, alimony and nontaxable combat pay.

A variety of financial institutions offer IRAs, including banks, savings and loans institutions, credit unions, brokerage firms and mutual fund companies. When you open an IRA, you deposit a specified amount of money and choose from various investments. Most IRA providers offer a variety of investment opportunities, including stocks and bonds, mutual funds, money market funds and CDs. This allows you to take advantage of a diversified mix of investments, which is a safe practice with your retirement money.

Deposits and Withdrawals

You can currently deposit up to $5,000 per year if you are 50 and under and $6,000 per year from 50 until the age of 70 ½. There are income limits that determine how much you can contribute to a Roth IRA, but none exist for a traditional IRA. Single filers who make in excess of $125,000 per year and joint filers earning more than $183,000 per year may not contribute to a Roth IRA in 2012.

You can withdraw money from your traditional IRA at any time, but you will have to pay a 10 percent penalty on the money you withdraw if you are younger than 59 ½. You will also have pay income tax on the money you withdraw. After 59 ½, you can withdraw funds without paying a penalty, but you will still have to pay income tax on the amount withdrawn. You must start withdrawing minimum distributions from an IRA each year when you turn 70 ½.

You can withdraw money from a Roth IRA before the age of 59 ½ without penalty providing that you only withdraw from the deposits that you put into the account, not any earnings.  There are no minimum distribution requirements for Roth IRAs.

A few exceptions exist to the 10 percent penalty rule. You can withdraw money from an IRA without being penalized in order to pay for college expenses, medical expenses greater than 7.5 percent of your adjusted gross income, up to $10,000 for a first-time home purchase and costs arising because of a sudden disability. You can also avoid penalties if you withdraw the money to roll over into another type of retirement account, such as from a traditional IRA to a Roth IRA.

The Benefits Of An IRA

An IRA’s biggest benefit is that your investments in the account grow on a tax deferred or tax free basis. This allows your money to grow faster than if you had to pay taxes on it each year.

Additionally, the 10 percent penalty for early withdrawals also reduces your incentive to pull money out of your account. This helps to ensure that you will have sufficient funds on which to live when you retire.

It's Not Free To Open And Maintain An IRA

Banks and other financial institutions have varying fee structures for IRAs so it’s a good idea to shop around. Some companies charge an annual account maintenance fee of $25 to $30, while others do not. There are also commission fees, which can range from as little as $7 to over $40.

Tax Planning

You can open an IRA at any time of the year, but the money must be filed by the tax filing due date. If you deposit money into an IRA after the due date, it will be considered a contribution for the following year's taxes.

Now that you understand the benefits and basics of opening an IRA, you can make informed choices that are likely to help you enjoy full, vibrant retirement years.

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