What is an IRA?
An IRA (Individual Retirement Account) is a type of investment program that offers tax incentives to help people save for retirement. The money that is in an IRA can be invested in a myriad of opportunities including stocks, bonds and mutual funds. You can elect to manage the money that goes into your IRA yourself, or you can pay a licensed professional to help you make investment choices.
The type of tax advantage you receive with an IRA depends on the type of IRA you choose
- Traditional IRA
With a traditional IRA, contributions (deposits made into the IRA) by an individual are tax deductible in the calender year made. The money that is earned in an IRA is tax deferred, which means that you do not pay income tax on any capital gains from your investments. The Internal Revenue Service (IRS) limits the amount you can contribute into an IRA each year (As of tax year 2004 this amount was between $3500 - $4000). You start paying taxes when you start taking disbursements (withdrawling money) from the IRA. This tax-deferral means that more of your capital gains are reinvested, so the value of your IRA will grow faster than it would if you made the same investments outside of an IRA. At retirement, you are likely to be in a lower tax bracket, so the tax on your capital gains from the IRA will be lower than if you had to pay capital gains taxes on the investments during your peak earnings years. As of tax year 2004, the IRS requires that the owner of the IRA start taking the minimum disbursement at no later than 70 1/2 years of age.
- Roth IRA
A Roth IRA is managed the same as a traditional IRA. The primary difference between the two is the tax advantages. With a Roth IRA, your annual contributions are not tax deductible, but when you start to pull the money out of the IRA at retirement, any capital gains you receive are not taxable (as long as you meet certain IRS requirements). The ability of someone to participate in a Roth IRA is subject to income restrictions set by the IRS as well as the amount of annual contributions. As of tax year 2004, the IRS does not require the owner of a Roth IRA to take any minimum disbursements by a certain age if the owner chooses not to.
IRAs are are offered by numerous financial institutions. When shopping for an IRA, be sure to compare any management fees that may be charged by each financial institution.