An IRA is an Individual Retirement Account, and it provides either a tax-deferred or tax-free way of saving for retirement. There are many different types of accounts within this category, depending on the financial goals and situations of each individual, though traditional and Roth IRAs are the most common choices.
A traditional IRA allows tax-deductible contributions of up to $4,000 US Dollars (USD) per year, or more if an individual is over age 50. Whatever the person contributes towards this account comes off his yearly income, thereby reducing his total tax liability. Once the money is withdrawn, however, it is subject to standard income taxes and an additional 10% penalty if withdrawn before the age of 59 1/2. An exception is made if the money is used for purchasing a house or to cover approved higher education costs. Standard income tax still applies, but the 10% penalty is waived. This provides a great investment tool with flexibility for important purchases.
Roth IRAs were created in 1997 to help middle-class Americans. They are not tax-deductible, but provide even greater flexibility than traditional accounts. Contributions can be withdrawn at any time without being subject to penalty or tax, though interest earned in the account is. After five years, both contributions and earnings in the account can be withdrawn without penalty or taxation. The same benefits concerning education and housing also apply as with the traditional IRA.
This type of retirement account isn't for everyone, though. Individuals who file taxes using single status are eligible for full contribution as long as they don't exceed $95,000 USD per year in earnings, and $110,000 USD for partial contributions. Joint filers face an earnings cap at $150,000 USD and $160,000 USD for full and partial contributions respectively. High-level corporate executives need not apply for this type of account.
Choosing IRAs can be complicated, depending on the financial situation, and may require the services of a certified financial planner. Another important decision may be whether or not to rollover a traditional one into the new Roth IRA. Generally speaking, if the person is eligible, contributing to a Roth account is always more advantageous due to the fact that income taxes will not apply later when the money is taken out, provided the person adheres to all the guidelines. Investors should be sure that there is enough time to absorb the costs of the rollover, however, since it will be taxed as if the person was taking the money out of the account.