Retirement might seem like a faraway world right now, but it’s never too early to start planning for your future, especially if you want to enjoy the fruits of your years of labor comfortably. Among the many options for retirement planning are annuities, 401k plans, and IRAs, or individual retirement accounts. Understanding IRAs will help you determine if they are the best option for you to use to reach your fiscal goals.
An IRA is a retirement savings plan that is arranged through an employer, a banking institution or investment firm, into which you contribute a certain amount of money, up to the legal annual maximum, for retirement savings. The money is dispersed into different investment options to generate a return. In most cases, some or all of your contribution can be deducted from your taxes and your principal and earnings are not taxed until withdrawal.
The most common types of IRAs are the traditional and the Roth IRA. Traditional IRAs allow you to invest the maximum allowed and use the money as a tax deduction, either partially or entirely depending on the requirements of the IRS. With a Roth IRA, you cannot use your contributions for a tax deduction but your earnings and distributions remain tax free, as long as you meet the stipulations of the IRS. An Education IRA is a special type of IRA into which you contribute a limited amount that grows tax free until it is used for educational expenses. A Simplified Employee Pension or SEP IRA is established by your employer, who can then put up to 15 percent of your income into a special IRA account. A SIMPLE IRA is also established by the employer, but it allows employees to make additional contributions up to a certain amount each year.
The most attractive benefit of an IRA is the tax break that it offers depending on which type you choose. The Roth provides tax-free earnings and distribution, which is particularly beneficial if you retire in a higher tax bracket than when you were working. IRAs also offer diverse investment options including stocks, mutual funds and other securities.
The most significant disadvantage of an IRA is the long-term commitment that it requires. Cashing in an IRA early may subject you to penalties on your distributions. The IRS charges an additional 10 percent tax for withdrawing IRA funds before the age of 59 1/2.
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