What is an IRA? Traditional IRA and Roth IRA

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If you are starting to think about retirement you may be asking yourself, what is an IRA?

Individual Retirement Accounts or IRAs are another form of retirement vehicle established under the IRS tax codes. There are a number of different IRAs but the two most common are the Traditional IRA and Roth IRA. Unlike your 401(k) plan that is offered via your employer, IRAs are considered self-directed and provide an option for investors when their employer does not offer a 401(k) plan.

Traditional IRAs

Similar to 401(k) plans money contributed to a traditional IRA are taxed at the time of withdrawal (59 1/2). In addition, similar to a 401(k), when you initially contribute, they have the ability to reduce your taxable income.

Roth IRAs

Roth IRAs are taxed at the time of contribution, but not taxed at the time of withdrawal. Investment returns once money is contributed to a Roth are not taxable. Roth IRA contributions can be most advantageous for younger investors because the IRA is taxed up-front, tax rates are typically lower for younger individuals because of their lower income level.

Here are the key points regarding IRAs.

They should not be considered liquid – assume that once you invest you’re contributing for retirement and the long-term, or possibly suffer penalties for early withdrawal.
IRAs can be opened at most banks, brokerage, and financial institutions.
Typically there is not a minimum investment level but check with your financial institution. Maximum contribution levels are $5,500 to $6,500 annually. Some of this may depend on whether you currently contribute to an employer-sponsored plan.
Risk – similar to a 401(k) they have what I consider a medium risk level.
IRAs normally provide more flexibility in regards to the mutual funds you can invest in based on how long you have to retire (varying degrees of risk investments). However, be sure to check with your financial institution. Some IRAs are set up to provide a rate of return that is slightly higher than a Money Market or CD. If you are saving for retirement you may want to look for a more aggressive IRA with returns that will benefit you over the long-term.

IRAs are a great way to start investing in your future. They provide the ability for you to direct deposit, which means you can contribute on a regular basis based on what you can afford. In addition, they have the ability to provide you with multiple investment options within the IRA (stocks and bonds), which provides you with flexibility based on your investment goals.

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