What is an Individual Retirement Account and What Are its Benefits?

What is an Individual Retirement Account (IRA)?

So what exactly is an IRA? Simply put, an IRA is a tax-advantaged investment account that enables you to save and grow retirement funds. Unlike an employer-sponsored retirement account (like a 401(k)), an IRA is an account you set up and manage on your own, giving you more flexibility in your investment choices.

IRAs can be great tools for savers who don’t have access to an employer-sponsored retirement account, or for those looking to augment their employer-sponsored plan with an additional account. Yes, you read that right – you can contribute to an IRA if you have an employer-sponsored retirement, though your ability to contribute to it may depend on factors like your income level.

What are the Different Types of IRAs Available?

There are four main types of IRA accounts available: a traditional IRA, a Roth IRA, a SEP IRA, and a SIMPLE IRA. We’ll cover the basics of the two most common types here – traditional and Roth IRAs.

Traditional IRAs

Contributions made to a traditional IRA are tax-deductible and investments grow tax-deferred. This can help lower your taxable income in the year that you contribute to it. That means you’ll pay taxes when you withdraw the money from your retirement account.

Roth IRAs

Contributions to a Roth IRA are made with after-tax dollars, meaning you pay taxes on the money prior to investing it in your Roth IRA. The other main difference from a traditional IRA is that withdrawals from a Roth IRA are tax-free in retirement, provided you meet certain conditions.

Rollover IRAs

A rollover IRA is created when you move funds from an employer-sponsored retirement plan, like a 401(k), into an IRA. This allows you to maintain tax advantages while benefiting from more investment options. A rollover IRA can be a great way to consolidate retirement accounts and simplify your investment strategy.

IRA Income and Contribution Limits

Income and contribution limits can change annually. For the most up to date information, refer to the IRS website. It can also be smart to consult a tax professional or financial advisor if you need more clarity on income and contribution limits. Note that this limit covers your cumulative contributions across all IRA accounts if you have more than one.

It’s also important to call out that 401(k) rollovers into IRA accounts do not count as a contribution. This means that you can still contribute up to the annual maximum even if you complete a rollover into the same account.

What Are the Benefits of an IRA?

IRAs are a popular choice for a retirement savings account for a number of reasons. Let’s take a look at a few of them.

No Employer Needed

Not all workers have access to a retirement plan through their employer. The good news is that independent contractors and blue collar workers, for example, can still benefit from a tax-advantaged retirement plan outside of an employer through an IRA. This can help open the door to a retirement savings strategy for those without a traditional employer-sponsored plan.

Flexibility

Since these plans aren’t employer-sponsored, you’re in the driver’s seat for selecting a provider to work with. This allows you to compare IRA providers across dimensions like fees, customer service, and more to find the best fit for you.

You’ll also be able to select what type of account you’d like: either an automated IRA or a self-directed IRA. Managed IRAs can be a great option for those looking to “set it and forget it” with growing their retirement savings. Self-directed IRAs are suited for those looking to manage their investments themselves.

More Investment Options

IRAs generally offer more investment options than traditional employer-sponsored retirement plans. These can include stocks, bonds, exchange-traded funds (ETFs), real estate investment trusts (REITS), and more. More options can help you build a diversified portfolio that better fits your personal investment strategy and long-term financial goals.

Consolidation Opportunity

Another great benefit of an IRA account is that you can use one to consolidate your retirement savings from old employer-sponsored plans into one account. As you progress throughout your career, it’s not unheard of to leave your retirement savings in old 401(k) plans along the way. With an IRA, you can consolidate the savings from those old accounts into a single IRA that you control through a 401(k) to IRA rollover. This can help simplify and streamline your retirement savings strategy.

Final Thoughts

Learning the ins and outs of retirement savings strategies can be complex. Fortunately, Individual Retirement Accounts are straightforward and offer tax benefits for those looking to plan their future. IRAs can provide you with flexibility and simplification in your journey towards retirement.

If you’re considering rolling over old 401(k) accounts to an IRA, consider using Capitalize to handle your 401(k) rollover for you. Capitalize is the industry’s first platform for digital retirement account transfers, and works with leading financial institutions like Webull to seamlessly roll over your retirement savings.

QUIZ

Which of the following is not a type of IRA?

1. Traditional IRA
2. Roth IRA
3. Thrift Savings Plan
4. Automated IRA

Which of the following are some benefits provided by an IRA?

1. Can help you consolidate your retirement savings
2. Can offer additional flexibility
3. Generally offers expanded investment options
4. All of the above