Does a traditional IRA earn interest? If yes, what rate can I expect from my investment on an annual basis? Do the rates vary or are they constant each year? If these are some of the questions that you have been asking yourself, you are in luck because, in today’s post, I will present information that I hope you will find educational with regards to this post. Read on till the end of the article to find out more.
Returns from Traditional IRAs – Introduction
The average growth rate of every IRA is dependent on a couple of factors, with some of the main ones being:
- The type of investments held through the account
- The average rate of return (based on a defined investment time horizon)
- The total contributions made by the account owner.
Until you start thinking about how you will withdraw the funds in your account, taxes will not play out, and will not affect the amount of money you will have earned. This is because traditional IRAs hold tax-deferred investments.
The average rate of return on traditional IRAs
Traditional IRAs earn interest rates, though the figures tend to vary widely from one investor to the other. According to S&P 500, however, the average rate of most IRAs is 10.8% per year. This is according to the data collected and analyzed in the period lasting from the start of 1971 to the end of 2020.
As already, highlighted, however, the rate of interest earned is dependent on several factors, which we shall discuss below:
The underlying investments
The government restricts the type of investment you can hold within your traditional IRA. You cannot, for instance, hold assets such as precious metals, cryptocurrencies, and artwork in this type of IRA. You are also not allowed to utilize your IRA funds to purchase life insurance.
In this type of Individual Retirement Account, you are mostly required to use your retirement savings to purchase paper assets such as:
- Exchange-Traded Funds
- Unit Investment Trusts (UITs)
Stocks have a high likelihood of performing well over time, though they can also end up disappointing investors. In the last 140 years, the average return rate for stocks (10-year rate) has been 9.2 %. S&P index has, on the other hand, had a 13.6% annual return. Stocks seem to be an investment option worth considering, especially if one intends to be a long-term investor.
The common and unspoken rule, however, is that you have to choose the right company, otherwise the poor performance of the companies you choose could cost you your retirement savings. It is also a good idea to invest early on the life of the company, to maximize your earning potential as the stock prices grow.
Bonds are also viable options, with their 5% to 6% returns, which as you can see are significantly lower than those of stocks. They are, however, more stable and thus possess a lower financial risk (more so when markets are unstable). They are also referred to as stocks when inflation is high, but with the higher than usual inflation rates in the recent past, bonds are beginning to lose popularity as well.
Total contributions made to the traditional IRA plan
The total contributions in one’s traditional IRA can also have a significant impact on the average return rate, more so over the long-term horizon. The less money you invest in your traditional IRA, the slower you can expect it to grow/compound over time.
The current IRA Interest rates
The current interest rate for your IRA is highly dependent on your choice of investment, as well as the platform you make your investment through. For instance, if you decided to put all your money in stocks, you can expect to earn about 9.2% returns (or more). On the other hand, if you decided to go with bonds in a bid to minimize risks, you will end up earning about 5 % to 6% returns. Chances are high that you will own a mixture of investments, and this will make your return rate different from that of other investors.
The prevailing market conditions e.g. geopolitical tensions and economic downturns play a significant role in the determination of the average return rate for the investments in a traditional IRA. With the occurrence of the global pandemic in 2020, for instance, we saw the global economy shrink by 4.4%. Many investments, including those held in traditional IRAs, lost their value.
In times of economic stability and prosperity, however, most investors reap handsomely from their investments held in their retirement savings and investment plans.
The time at which you start investing
When investing, time is your greatest ally. Even with a traditional IRA, the value of your investments will increase significantly if held in the account over a long period. The good thing is that you will not need to pay taxes until you are ready to start making withdrawals. The earlier you start investing through your traditional IRA, the better off (financially), you can expect to be.
Renowned Investor, Warren Buffet, encourages people to invest early and let compound interest do the work for them, which is something he learned after having invested from a tender age of 11 years. Another sound strategy is opening a self-directed IRA, which enables you to invest in a wider variety of assets, hence maximizing your earning potential. Some investors also swear by Gold IRAs (special types of self-directed IRAs that allow investors to hold IRS-approved precious metals), owing to the stability that they bring to their portfolios.
You are a smart person and I am absolutely sure that you will find the best alternative for your particular need. You can learn more through the links below of our top-recommended gold & silver IRAs to get a clear picture of what best of the best firms in this industry has to offer:
That will be all for today’s post, and I hope you now have the answers to the question “does a traditional IRA earns interest?” Regardless of the type of IRA you currently have, it is a good idea to think about the future and to ensure that your retirement savings are not eaten into by the declining interest rates. This, to a great extent, depends on the factors we have discussed above, along with whether you have assets that can withstand negative market forces. This is the only way to get through the financially challenging times and enjoy the times of economic prosperity.
I wish you well,
Eric, Investor and Team Member at Gold Retired!