An individual retirement account (IRA) is a type of retirement savings account that allows individuals to contribute funds towards their retirement in a tax-advantaged manner. This financial tool enables individuals to set aside money for their golden years, benefiting from potential tax advantages while reducing their taxable income.
With an IRA, individuals can self-direct their investments, choosing from a wide range of options, such as stocks, bonds, mutual funds, and even real estate in some cases. Contributions to an IRA are typically tax-deductible, meaning that individuals can deduct the amount invested in their IRA from their taxable income, potentially resulting in a lower tax bill. However, the tax advantage is limited up to a certain amount, and it can vary depending on factors such as income and participation in an employer-sponsored retirement plan.
The growth of investments within an IRA is tax-deferred, meaning that individuals do not pay taxes on any capital gains, dividends, or interest earned until they start withdrawing the funds in retirement. At that point, the withdrawals are considered taxable income. This can allow individuals to potentially accumulate more funds in their account due to compounded growth over time without immediate tax consequences.
Two of the most common types of IRAs are Traditional IRAs and Roth IRAs. The main distinction between the two lies in the timing of the tax benefits. Traditional IRAs offer tax-deductible contributions and tax-deferred growth, while Roth IRAs allow for tax-free withdrawals in retirement, but contributions are made with after-tax dollars.
