What Is an Individual Retirement Account?

The term IRA is used to describe individual retirement accounts and the Internal Revenue Service’s broader definition of individual retirement arrangements.

An individual retirement account is a type of individual retirement plan that offers tax advantages for people saving for retirement.

Depending on the type of IRA you have, you may make contributions to the plan now, but not have to pay taxes until you withdraw money from the IRA. Or you may contribute after tax money now and have no taxes to pay on money you withdraw from the IRA after you retire.

You can contribute earnings each year up to a maximum amount allowed by the IRS.

IRAs are also an option to consider if you have accumulated money in your employer’s 401(k) plan and you leave your job, whether you are retiring or taking a new job. You may want to consider a rollover.

The term “rollover” describes a tax-free distribution or movement of your assets from one retirement plan to another. Moving the money into the second plan is called a “rollover contribution.”

You can choose to move the assets to your new employer’s retirement plan, leave them where they are, cash out your assets or roll them over into an IRA.

Unlike 401(k) plans, which are retirement accounts set up by your employer, IRAs are retirement plans that you set up on your own through a financial institution or advisor.

Once you open an IRA, you invest money into the IRA account. You can invest in stocks, bonds or other assets that can grow your investment. In the case of self-directed IRAs, you can even invest in alternative asset classes like cryptocurrency, tax liens and gold.

You can continue contributing to keep your IRA investments growing, but there is a maximum amount of money you can invest each year.

You can withdraw money from your IRA at any time, but if you do it before you are 59.5 years old, you can face a penalty equal to 10 percent of your withdrawals and get hit with a tax bill for the money you take out.

There are several different types of IRAs, but most fall into one of four different types: Traditional, Roth, SEP or SIMPLE IRAs.

Even if you already have a 401(k) or another employer-backed retirement plan, you can still set up an IRA, giving you another source of retirement income.

You may also want to invest up to the maximum amount each year to maximize your potential retirement savings. Talking to a licensed financial professional can help you understand what amount of contributions works best for your financial situation.

One of the biggest benefits of an IRA is that it allows you to invest while deferring taxes on the income you contribute until you withdraw the money. But you are only allowed to contribute certain types of income under the law.

Some parents and grandparents even choose to open custodial IRAs for their dependents, giving them the gift of tax-free growth on investment starting from a very young age.

You can only invest earned income into an IRA. Under federal rules, you can’t use income sources that the IRS does not consider taxable earned income.