Money — 5 months ago

What is an IRA and How it Works?

by Garry S.

IRA, What is an IRA, Roth IRA

How Does Retirement Savings IRA Help You Save Money for your Retirement?

An IRA or Individual Retirement Account is an account where you can save money for your retirement on a tax-free growth basis. Almost anyone with a steady income can open an IRA. It belongs to the individual alone and is not associated with the employer in any way. 

There are two types of IRAs having different benefits:

1: Traditional IRA

In this type of IRAs, the money you contribute to the IRA account can be deducted from your tax returns while you are employed. Any growth in the earnings is also tax-deferred. You only pay taxes when you withdraw an amount after retirement. And since most people fall under a lower tax bracket post-retirement, you will be taxed at a lower rate on withdrawal. So you save on taxes when you are employed and contributing to the IRA and pay lesser tax when you finally withdraw the funds after retirement.

IRA

2: Roth IRA

Under this scheme, you contribute to the IRA after paying your taxes, while you are employed, and enjoy tax-free withdrawal after retirement. That means, you are paying more tax when employed than with a Traditional IRA, but when you withdraw you get to keep the entire amount without the hassle of having to pay taxes. The condition for tax-free withdrawal, though, is that you withdraw at least five years after your first contribution to the Roth IRA and you are older than 59 ½ years.

Types of contributions - Rollover or Startup

In case of a Rollover IRA, you can transfer the amount from an already existing qualified retirement plan to your IRA contributions. Under Startup IRA, you make an initial deposit to fund your IRA directly.

Contribution limits

The IRAs have a limit on the maximum amount you can contribute in a year. The maximum amount you can contribute to an IRA in a year is $5000. This limit is total which means that if you more than one IRAs, the total contribution you make to all of them must not exceed $5000 in a year.

What is an IRA
People who are 50 years old or older are allowed an extra contribution of $1000 a year to increase their savings for retirement. If you contribute more than $5000 in a year to the IRA, you will be penalized with a whopping 6% on the excess amount. For Roth IRAs though, there are a few rules that determine whether or not you can contribute the full $5000 to the IRA account.

Traditional or Roth IRA- Which one is better?

This decision is purely personal and should be made after acquiring a clear understanding of the benefits and drawbacks of both types. In general, people who feel that their post-retirement tax rate will be lower than their current tax rate can enjoy the benefits of the tax-deferred growth of a Traditional IRA.

On the other hand, people who feel that their post-retirement tax rate will be higher than their current rate can save by opting for the tax-free growth in a Roth IRA.

Roth IRA

How does an IRA help with saving for your retirement?

An IRA is a more or less hassle-free way to save for your old age. It is an individual IRA account and has nothing to do with your employers. This gives you the freedom to choose when and what you contribute or withdraw. You can access any investment options within the IRA-like savings accounts, mutual funds, stocks, bonds and many more. You can combine all your savings from other retirement plans into one IRA, making your savings easier to handle.

An IRA is an excellent way to save for your retirement while enjoying its tax benefits. This account, along with other savings plans, can go a long way in giving you an independent worry-free life even after your retirement.


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