An IRA (Individual Retirement Account) is a type of savings account in which you place earnings from bonds, stocks and other investments. IRAs are similar to 401ks in theory, but they are different in principle. 401ks are composed of the same types of investments, but they are offered by your employer. In most cases, your company will also contribute to your 401k account as an incentive. IRAs, on the other hand, are invested in solely by you, sometimes with the help of an investment advisor.
The money you put into an IRA is not taxed. However, when you pull out the money when you reach retirement, you will pay taxes on that amount. You can save yourself the headache by paying taxes in advance. This type of IRA is called a Roth IRA. Keep in mind that if you pull the money out of an IRA earlier than your projected retirement date, you will likely pay a penalty.
The IRS also places limits on the amount of money you contribute, lest you be taxed on your contributions. You can invest up to $5,000 a year if you are under the age of 50, and $6,000 per year after that.
Although an IRA mimics a traditional savings account offered by your local bank, there are more restrictions involved. First, you may have to meet a certain income level. If you are self-employed, you are not eligible for some IRAs. This is kind of a Catch-22 situation, since you also cannot participate in a 401k program if you are self-employed.
An IRA is a smart way to save money for retirement, because the IRS allows tax breaks for a limited amount of money every year. Plus, an IRA is diverse so that if one investment, such as a stock, does not pan out, you have other solid investments to rely on. IRAs are offered through brokerage firms, mutual fund companies and major banks.
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