What Is an Individual Retirement Account?

What Is an Individual Retirement Account?

By Charles Joseph | Editor, Financial Affairs
Reviewed by Corey Michael | Senior Financial Analyst

An Individual Retirement Account, often known as an IRA, is a type of savings account designed to help you save for your retirement. It’s set up through a bank or other financial institution and provides certain tax advantages. There are different types of IRAs, such as Traditional IRAs, Roth IRAs, and SEP IRAs among others. Each type comes with different rules, limits and tax benefits that can suit different needs and circumstances.

Related Questions

1. What is a Traditional IRA?

A Traditional IRA allows you to make contributions with pre-tax dollars. This means your contributions can be deducted on your tax return, potentially lowering your yearly tax bill. The downside is you need to pay taxes when you withdraw money during retirement.

2. What is a Roth IRA?

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A Roth IRA is funded with after-tax dollars. This means you pay taxes now, but withdrawals in retirement are usually tax-free. These are often best for those who expect to be in a higher tax bracket when they retire compared to when they make contributions.

3. What is a SEP IRA?

A SEP IRA stands for Simplified Employee Pension Individual Retirement Account. It’s designed for self-employed individuals or small business owners. Contributions are tax-deductible and you pay tax on withdrawals during retirement, similar to Traditional IRAs.

4. How much can I contribute to an IRA?

The contributions limits to an IRA vary from year to year and depend on your age. For 2021, if you’re under the age of 50, you can contribute up to $6,000. If you’re 50 or older, the limit is $7,000.

5. What happens if I withdraw money from my IRA before retirement?

In most cases, an early withdrawal (before the age of 59 ½) from an IRA results in a penalty plus taxes. Generally, it’s a 10% penalty, on top of which you have to pay regular income tax on the amount withdrawn.