What is an IRA?

When planning for a sound financial future, IRAs are a great way to go. They can be confusing, especially if you've never heard of them. But, they don't have to be intimidating. With a little bit of exposure, you can find a way to figure IRAs into your monthly budget planning and into the larger picture of your financial life.

What is an IRA?

An IRA is an abbreviation for an Individual Retirement Account which will, not surprisingly, help you save for your retirement. They usually offer some sort of tax advantage, depending on the kind you choose, and usually cannot be withdrawn from until your retirement, offering a steady way to save at least part of your income, even in the early years of your working life. For any type of IRA considered, it is best to go see your bank by making an appointment with an adviser there, who may tell you what's best for your particular situation.

The way to access IRAs is also usually through bank accounts or financial advisers. For all types of IRAs, there are usually contribution limits. For both traditional and Roth, the contribution limit is $5,000 if you are 49 and below and $6,000 if you are 50 and above. Because of the tax advantage, it's usually best to try to make the full yearly contribution, especially since you can't deposit more than the contribution limit in any given year. You also cannot withdraw the amounts, which are subject to penalty fees if you are under 59 and 1/2. Over 60, you are free to withdraw the money at your will. There are several ways to get out of fees, including permanent disability and higher education costs, but it is better to put the money in knowing it is for your long-term plans.

IRAs should be supplemented with contributions from work such as 401(k)s. If you have a matching 401(k) program, be sure to take full advantage of it. There are several types of IRAs to consider: traditional, Roth, SIMPLE, and SEP.

Traditional IRA

In this IRA, contributions (any money you put in during the year) are tax-deductible and all transactions and earnings have no tax impact, meaning it is to your advantage to start this type of IRA in order to avoid paying more taxes at the end of the year. After you retire, all transactions are taxed as income.

Roth IRA

In a Roth IRA, you usually deposit money with after-tax income (meaning from your paycheck or otherwise), and they also have no tax impact. However, they are not tax-deductible as traditional IRAs are. The upside is that they don't cost you anything going in, while Traditional IRAs don't cost you anything going out.

SIMPLE IRA

This type of IRA is most like an employee savings plan in that it allows both you and your employer to contribute. The difference is that the limits for contributing are much lower and the rates are much simpler, allowing for less cost of administration.

SEP IRA

This plan usually works if you are self-employed or own a small business, and allows you, as the employer, to make contributions into a traditional IRA plan by replacing your retirement plan entirely with the IRA.