What Is an Individual Retirement Account?
There is more to saving for retirement than your company’s 401(k) plan. You also have the option to set up an Individual Retirement Account, better known as an IRA. These tax-advantaged accounts let you set aside money every year until you retire, at which point you can take distributions to fund your retirement. You can even use an IRA if you’re self-employed. Learn more about these accounts and what they entail.
Individual Retirement Account Definition
An individual retirement account (IRA) is an investment account used to save for retirement, and special tax laws apply. There are several kinds of IRAs, each with its own advantages. Self-directed, IRAs reward you with tax savings, either at the front-end (as you save) or the back end (as you withdraw).
IRAs let you supplement your 401(k) or pension plan, which may not be enough to support your retirement goals. You also have a much wider range of investment choices, unlike a typical 401(k), so you have much greater control over how your money is invested. That could help you save on fees, which can be high on some actively managed mutual funds (often found in a 401(k)).
Types of Individual Retirement Accounts
There are a few main types of individual retirement accounts.
As is clear from the name, Traditional IRAs are the traditional form of this investment vehicle. You make pre-tax contributions, which may help lower your taxable income in the present. You are only taxed when you take distributions — and since you may be in a lower tax bracket at that time, you could be taxed a lower rate, for significant savings. You can use your IRA to invest in nearly any kind of asset, such as stocks, bonds, mutual funds, and ETFs (exchange-traded funds). You choose the assets and their allocation — it’s your choice how to invest.
With a Roth IRA, you deposit after-tax money, so your contributions grow tax-free. Your distributions can be tax-free, too (if you meet certain requirements), so this is a great way to save, especially if you expect that your income will only increase (meaning a higher tax bracket in the future). Just like a Traditional IRA, you can use a Roth to invest in many types of assets. Just be sure you meet the income requirement: $140,000 if single, $208,000 if married.
If you change jobs, you have the opportunity to take your 401(k) funds with you by “rolling them over.” In an individual retirement account, rollover contributions are a way for you to simply transfer the funds out of the 401(k), skipping any penalties, fees, or taxes for taking the money out early. Depending on the IRA type you may owe taxes later, or a penalty if you decide to take the money out early, but you aren’t punished for taking the money out of the 401(k).
Perhaps a lesser-known vehicle is the Individual Retirement Account CD (IRA CD), which lets you save for retirement in a CD. As with regular CDs (certificates of deposit), you deposit your money and agree to let it sit for a specified amount of time in exchange for interest. Withdraw early, and you’ll have to pay a penalty.
IRA CDs can have term lengths of as many as 10 years. You may not get the same yield as investment into stocks, but the advantage is a steady rate and dependable return. Plus, CDs can be FDIC-insured—unlike investments, which are subject to the risk of losing principal. And CDs don’t have management fees like mutual funds do.
The Best Individual Retirement Account
Choosing the best individual retirement account will take some evaluation of your current financial situation and where you expect to be in the future, especially at retirement.
Ready to start saving for your financial future now? Open an IRA with Consumers National Bank with just $100 to start. Talk to one of our bankers to find the best solution for you.