What is an IRA?

What is an IRA?

An IRA is a specific kind of investment account that entitles the investor to certain tax breaks. The IRS grants these tax benefits to encourage Americans to save for retirement.

In exchange for the tax benefits, there are some restrictions on IRA accounts.

For example:

There are limits to how much money you can contribute to an IRA each year. In 2018, this is $5,500 for investors under the age of 50. Age 50 and over it's $6,500

There is a 10 percent penalty for withdrawing money from an IRA before you turn 59 1/2. (With a few rare exceptions.)

To open an IRA, you need to decide whether to open a traditional IRA or a Roth IRA.

Traditional vs. Roth

There are two major kind of IRAs: Traditional and Roth. Both provide tax breaks to save for retirement, but they work differently.

With a traditional IRA, the money you deposit now is tax deductible. Earnings accumulate tax-free, but you pay ordinary income tax when you withdraw the money.

With a Roth IRA, you cannot deduct money that you deposit from your taxes now. Earnings accumulate tax-free and you withdraw the money tax-free in retirement.

Two other notable features of a Roth IRA are:

You can withdraw money you saved in a Roth IRA anytime without penalty (but you cannot withdraw any earnings without penalty until retirement).
Investors who earn more than a certain amount cannot take advantage of a Roth IRA without a Roth IRA conversion — a more sophisticated financial planning move.

Which kind of IRA should the majority of Americans open?

Roth IRA. The long term benefits strongly outweigh the short term benefits. 


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