What is an IRA? Are there different types of IRAs? What can you invest through an IRA? Are IRAs a must-have, or can you survive without one? Welcome to today’s post in which we shall take a look at what IRAs are all about, in a bid to help you make a decision about whether to open one today. Read on till the end of this article to find out more.
What is an Individual Retirement Account (IRA)?
An IRA is a unique tax-advantaged investment account, that you can use to save for your retirement years. The most common types of IRAs today include traditional, Roth, SIMPLE, and SEP IRAs, all of which offer their benefits to those who use them to save. You can open your IRA through any of the approved financial institutions, most of which are banks, robo-advisors, or brokers. The contributions made to the IRA, or the withdrawals you take during your retirement years, maybe tax-deductible or tax-free, depending on the type of IRA.
For the sake of clarification, the IRAs we are talking about here have nothing to do with the Irish Republican Army. We are solely focusing on the retirement accounts that are overseen by the IRS.
How do IRAs work?
When you invest your money in an IRA, you allow those funds to grow and compound. Depending on the type of IRA, you can invest in assets such as:
- ETFs., etc.
The rate at which the money in your IRA grows is dependent on the investment time horizon, the amount that you contribute annually, as well as the type of investments that you choose.
As a prudent investor, you have to always put into perspective some elements such as your financial situation and expectations, and your overall risk tolerance. It is also safe to say that the money you contribute to your IRA should not be money that you intend to use in the near future. It should, instead, be money that you are willing to hold for a long time, as it grows at a satisfactory rate to guarantee you the financial security you need during your retirement years. Not forgetting that you have to invest in such a way that your IRA outperforms inflation.
Generally, IRAs have contribution limits. You and your spouse (if you have one) need to have an earned income, to make your annual contributions to your IRA. Provisions are made for those who are unemployed, or who face unemployment after opening their IRA.
There are also strict withdrawal rules that you are required to uphold always. If you fail to uphold the withdrawal rules, you risk facing a 10% penalty as well as a tax bill. Those who withdraw their money before 59 ½ years, or fail to withdraw their money ( required minimum distributions) after 72 years, risk being penalized and heavily taxed.
Why should you consider investing in an IRA?
The top benefit of investing some of your money in an IRA is the ability to select from a wide variety of investment options. With a 401(k) or pension scheme that is provided by your employer, you may not have the same investment options and choices.
IRAs also enable you to save a significant amount of money on taxes, as you maximize your returns by selecting the most suitable assets. In addition to this, you can turn to your IRA service provider in the event that you face an emergency that qualifies as a situation that allows for you to take withdrawals, including:
- Higher education expenses
- Qualifying disability
- Death (funds are given to the appointed beneficiaries)
- First-time home purchase
Is it better to open a 401(k) or an Individual Retirement Account?
Depending on your annual income, you can open both. This way, you can get the full employer match on the funds that you contribute to your 401(k), as you also take advantage of your IRA plan to boost your retirement savings.
If your employer does not match your 401(k) contributions, or if you intend to max out your 401(k) savings, or if the 401(k) plan has a limited range of investments, or even has very high fees, it would be a good idea for you to open an IRA as your retirement investment vehicle.
The main difference between an IRA and a 401(k) plan is that the 401(k) plans are usually offered by employers, while you are expected to open an IRA yourself, with the help of an IRA broker or bank. Not forgetting that IRAs typically offer a wider variety of investment options, but 401(k)s typically allow you to make higher annual contributions.
The good news is that, if your retirement savings are held in a 401(k), you can roll them over into an IRA. One of the top benefits of a rollover IRA is that if the rollover process is carried out in the right manner, the funds keep their tax-deferred status, hence you do not have to worry about the process triggering taxes or the early withdrawal penalties.
How does one open an IRA?
The common ways people use to open their IRAs are through brokers and robo-advisors. Opening an IRA with a broker gives you the liberty to choose the investments for yourself. If you, therefore, intend to be more in control of the investments that find their way into your IRA, then online brokers will be the best option for you.
Robo-advisors, on the other hand, come in handy for those who would need help with the management of their IRA. Most robo-advisors select low-cost and low-risk investments for you, depending on your risk profile and retirement investment objectives.
You can alternatively open a self-directed IRA, in which you get to make all the investment decisions, and invest in non-traditional assets such as precious metals and cryptocurrencies. See our top-recommended self-directed IRA service providers below:
That will be all for this post on what an IRA is about. My hope is that you found it helpful and that you now know whether an IRA is a necessity as you head to your retirement years. Let me know if you have more questions with regards to this subject, or if you need help with deciding the best type of self-directed IRA for you- drop the question in the comments section and I will get back to you ASAP.
I wish you well,
Eric, Investor and Team Member at Gold Retired!