Investing 101 ? What is an IRA? | Investments

Investing 101 ? What is an IRA?

Article by Kyle W Bumpus

The Individual Retirement Account (or IRA), was created by Congress as a way to provide tax-advantaged retirement savings to workers not covered under an employer-sponsored plan. Unlike a 401k plan, an IRA doesn?t need to be sponsored by any particular employer. They can be opened directly at any number of reputable fund companies and can be invested in practically any asset you can imagine, unlike 401k plans which generally limit you to a few pre-approved funds in the major asset classes.

<strong>Traditional or Roth?</strong>

IRA?s come in two primary flavors, Traditional and Roth, which differ in their tax treatment. Both share the same contribution limit, which for 2009 is ,000 and both carry a 10% early-withdrawal penalty if you take money out of the account before age 59 1/2 (barring certain hard-ship exemptions). There are other special kinds of IRA?s (SEP IRA, SIMPLE IRA, non-deductible IRA etc), but they aren?t applicable to the the vast majority of investors and so we won?t consider them here.

<strong>Traditional IRA?s</strong>: A traditional IRA allows you to deduct your contributions in the current tax year, much like a 401k. For example, if you were to contribute ,000 to a traditional IRA this year (and met certain eligibility requirements), you could deduct ,000 from your taxable income this year, effectively avoiding paying taxes on your contributions, at least for a while. The catch is that you will owe regular income tax on the entire amount you remove from your IRA during retirement.

<strong>Roth IRA?s:</strong> A recent invention, the Roth?s tax treatment is essentially the opposite of that of a Traditional IRA. Instead of being able to write off your contributions every year, you pay full income tax on every dollar invested in a Roth. However, you will never owe any tax on your earnings or contributions again. All future withdrawals will be 100% income-tax free. This is a potentially huge advantage for investors of all ages, but young investors especially. Since young investors tend to have lower incomes than their more experienced coworkers, they tend to be in a much lower tax bracket. If you are in a low tax bracket, you?re often better off paying taxes now as opposed to later. The opposite is usually true if you?re currently in a high tax bracket.

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Source: http://investmentshowto.com/investing-101-what-is-an-ira/

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