What Is an IRA Cash Reserves Account?

One of the best ways to put aside money for your golden years is by contributing to an individual retirement account. When you're young, keeping retirement funds in a cash reserve account is probably too conservative an investment, as your money has less chance to grow. As you get closer to retirement, you might want to transfer some of your IRA money into the safety of a cash reserve account or other money market account.

Individual Retirement Accounts

IRAs allow you to put away up to $5,000 per year (or $6,000 once you're over 50) in tax-deferred or tax-free accounts for retirement. If you fund a traditional IRA, the money is tax-deferred, and although you can take it out of your account at any time, if you withdraw from your traditional IRA before you reach 59 1/2, you will have to pay a penalty. You must start taking withdrawals by the age of 70 1/2. If you don't have a retirement plan at work, you can deduct your traditional IRA contribution on your income tax return. You can fund a Roth IRA with after-tax dollars, which doesn't permit an income tax deduction but allows you to make tax-free withdrawals without penalties after the age of 59 1/2. Unlike the traditional IRA, there is no mandatory requirement to take withdrawals from a Roth IRA by a specific age. A Roth IRA is more flexible, allowing you to withdraw money without penalty to purchase a first home or if you suffer a serious medical problem.

Cash Reserve Accounts

Banks and other financial institutions offering cash reserve accounts invest for safety of principal. Mutual funds offering such accounts invest in money-market securities in U.S. dollar-denominated funds, seeking a stable share price of $1 per share. Cash reserve funds seek to preserve liquidity and capital while providing income. The interest rates paid by cash reserve accounts are subject to change. When interest rates are low, so is the return.

Benefits

Many banks and other financial institutions with cash reserve accounts allow you to start saving for retirement by putting away small amounts of money in an IRA, perhaps as little as $10 a month. While the money accumulates, you can research other IRA investment options offering higher returns and more volatility in which to eventually transfer your nest egg. When you're young, you can take more risk with retirement funds because you should have the opportunity to make up for any down years over time.

Drawbacks

If your cash reserves IRA is in a bank insured by the Federal Deposit Insurance Corporation, you can't lose the principal in event of a bank failure unless the amount exceeds $250,000. While that's the good news, the bad news is that keeping your retirement fund in a safe cash reserves account while you're young almost guarantees that your investment won't keep up with inflation. Once you save enough in your cash reserves IRA to open an account in a stock mutual fund or similar growth option, consider transferring your IRA.