An Individual Retirement Account (IRA) is a retirement savings account set up with a financial institution or brokerage firm that offers tax breaks for those investing income for their retirement.
IRAs allow for stocks, bonds and mutual funds to be used to save for retirement and can be used for a wide range of investments when self-directed, including real estate, private placements and tax liens.
Generally, IRAs allow individuals to save $5,500 a year, with an additional $1,000 in catch-up contributions allowed for those over 50 years of age. Penalties of 10% generally apply for withdrawals before the age of 59 ½. Once entered into an IRA, cash assets can be converted into and between different securities, such as stocks and bonds.
There are certain types of IRAs for different types of individuals, including traditional IRAs and Roth IRAs.
Traditional IRAs allow tax-deductible contributions. Withdrawals are taxed at the current tax rate when funds are withdrawn from the account, but any transactions within the account are not taxed. This works best for investors who think their tax rate will go down in retirement, which positive for those at the top of their salary or far along in their careers. Two types of traditional IRA are Savings Incentive Match Plan for Employees (SIMPLE) IRA, which is similar to a 401(k) plan, and Simplified Employee Pension (SEP IRA), which is for small businesses to set up for employees.
Unlike traditional IRAs, Roth IRAs do not offer a tax deduction on contributions, but funds withdrawn in retirement are not taxed. This is useful for those who expect to have higher post retirement income tax levels than at the time of their investment. MyRA, introduced by the Obama administration, is a type of Roth IRA.
It is possible to have both traditional and Roth IRAs, but contributions to both combined may not exceed yearly contribution limits.