Understanding IRAs: The Benefits of An Individual Retirement Account

Zoe Team

Jun 19, 2020

4 min read

A financial advisor reviewing a plan with two clients at a table

Key Takeaways

IRAs offer tax-advantaged ways to build retirement savings effectively.
Starting early maximizes potential growth through compound interest over time.
IRAs provide flexibility to complement existing employer-sponsored plans.

Frequently Asked Questions

What is an Individual Retirement Account (IRA)?

An IRA is a tax-advantaged account designed to help individuals save and invest specifically for retirement purposes.

What are the main benefits of an IRA?

IRAs offer tax-deferred or tax-free growth, helping your savings accumulate more effectively over the long term.

Who is eligible to open an IRA?

Most individuals with earned income can contribute to an IRA, providing a accessible path for retirement planning.

Although retirement can be anxiety inducing, it can also be quite exciting. Now is the time for you to take that trip to Bali you’ve always wanted or take up a hobby that got put on hold in your 20’s. Nevertheless, for those that don’t feel confident in their retirement savings, this can be a stressful time in their life. A recent Forbes publication found that there are 3 main fears linked to the lack of retirement confidence in Americans: fear of long-term expenses, fear of debt, and fear of low returns on savings accounts, bonds, and bond funds. Fortunately, you can act to subdue retirement concerns by setting up an individual retirement account (IRA) and reaping IRA tax benefits.

What Is An Individual Retirement Account?

An individual retirement account (IRAs) is an account set up at financial institutions that allows you to save money for retirement. Because IRAs are used to complement your current savings, it’s a great investment for your future. An IRA may be useful to you if you have a separate retirement fund (such as a 401k) that you want to rollover into your IRA to steer clear of early withdrawal taxes. The biggest advantage to an individual retirement account is the tax benefits.

Tax Benefits of an Individual Retirement Account

Your savings in an individual retirement account will be tax-deferred, meaning they won’t be taxed until they’re withdrawn. This is a great advantage because these savings can grow without annual taxes on dividends and interest income. In addition, when a person retires and starts withdrawing from the account they are likely be in a lower tax bracket and thus pay fewer taxes.

You can defer the taxes on your IRA up until you are 70.5 years old. Although many people make withdrawals as soon as they retire, which is usually at the age of 65, it is beneficial to wait. You can take these years to continue accumulating investment income. This extra money that you’ll possess when you turn 70 will give you an additional financial cushion. Your savings will continue to grow because IRAs have more investment options than employer-sponsored plans, meaning you can earn higher investment returns.

Example: Laura invests $5,000 in the tax-deferred IRA and the account value grows 5% from the appreciating value of the investments or interest income. By the end of the year, her account has $5,250; Laura won’t have to claim the extra $250 as investment income on the current year’s tax return because it was earned inside an individual retirement account. From there, the account may continue to grow in the following years.

How to Get an Individual Retirement Account

If you’re interested in investing in your financial future, you are probably curious as to how to get an individual retirement account. The first thing you should consider is what kind of IRA fits your needs. There are 3 main types: traditional IRA, Roth IRA, and Rollover IRA.

Traditional IRA: This is the
most common individual retirement account
that people select. In a traditional IRA, you can place money into your account that will not be taxed until it is withdrawn.

Roth IRA: With this option, you’ll be contributing money that you’ve already paid taxes on, thus it will accumulate tax-free investment income. Because the taxes were paid initially, you won’t need to pay any more taxes during withdrawal.

Rollover IRA: In a rollover IRA, you’ll take money from your
employer-sponsored retirement fund
and place it into your IRA. This investment will also have a
tax
-deferral until withdrawn.

All of these individual retirement accounts have tax benefits, but the main differences are where you’re getting the money from and when the money will be taxed. After you decide which plan you prefer, you have to choose where you’d like to open your account. As previously mentioned, an individual retirement account needs to be opened with a financial institution (banks, mutual fund companies, and brokerage firms). As with any investment, you should consider the trading fees and other charges, such as maintenance or custodial fees, that the institution may impose. Each institution varies in what they will charge; some may even have special deals for new accounts.

Finishing the Process

After you select the appropriate plan and institution, the hardest part is over! Now you’ll just need to make it official by signing some documents and funding your account. After that, you can continue to invest and watch your money grow. If you would like assistance throughout this process, there are financial advisors that specialize in this area. Remember that an individual retirement account is meant to provide you with a more comfortable lifestyle once you retire, so it’s never too early to start.

What Is An Individual Retirement Account?

Tax Benefits of an Individual Retirement Account

How to Get an Individual Retirement Account

Traditional IRA: This is the
most common individual retirement account
that people select. In a traditional IRA, you can place money into your account that will not be taxed until it is withdrawn.

Roth IRA: With this option, you’ll be contributing money that you’ve already paid taxes on, thus it will accumulate tax-free investment income. Because the taxes were paid initially, you won’t need to pay any more taxes during withdrawal.

Rollover IRA: In a rollover IRA, you’ll take money from your
employer-sponsored retirement fund
and place it into your IRA. This investment will also have a
tax
-deferral until withdrawn.

Finishing the Process

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