What is an IRA?
When envisioning retirement, many individuals imagine traveling, enjoying
hobbies and spending quality time with family and friends.
The truth is, a dream retirement — even one spent doing nothing — takes careful
planning and thought. It is up to you to lay the financial foundation for all
of the things you want to do when you are no longer employed.
Regardless of your age, you can start planning for your retirement now with one
of the best save-for-tomorrow tools at your disposal: an IRA, or Individual
Retirement Account.
Simply put, an IRA is a tax-advantaged account that can hold many different types
of investments: stocks, bonds, mutual funds, annuities, certificates of deposit and more.
Once you open an IRA, your money grows tax deferred over time. When you are ready to
access your money, you can convert your IRA into a steady stream of retirement income.
There are two basic types of IRAs — traditional and Roth — and each are tax-advantaged
savings plans that allow you to invest a maximum amount each year for retirement.
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With a traditional IRA, you may be able to deduct your contribution from your
taxable income, thus reducing current federal income taxes.
This depends on your income and if you are covered by a retirement plan at work.
While your money grows, taxes are deferred. You will be subject to ordinary federal
income taxes when you withdraw the money, generally at retirement.
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With a Roth IRA, you cannot deduct your contribution from your income for federal
income tax purposes. However, qualified withdrawals of earnings are federal income
tax-free.
If you withdraw earnings before the account has been open at least 5 years or before
age 59½, you are generally subject to federal income taxes and a 10 percent
penalty on the amount of earnings withdrawn.
Contributing To An IRA
IRAs were created to help Americans save for retirement.
Who may contribute? Almost anyone, as long as their earned income for the year equals
or exceeds the amount of their contribution. Married couples may each contribute to an
IRA, even if only one has an income, as long as the working spouse’s earned income is
large enough to cover the contributions for both.
Because contributions to Roth IRAs are made with after-tax income, your contributions
may be withdrawn tax-free at any time — and you do not have to pay the money back.
That makes the money inside a Roth IRA “liquid,” or easily accessible (although it may
be subject to market risk).
Imagine that you have made $50,000 in contributions to a Roth IRA that has increased in
value to $75,000. Because the $50,000 was contributed from your after-tax income — in
other words, it is money that has already been taxed for federal income tax purposes — you
may withdraw up to the entire $50,000 completely tax-free, regardless of your age.
Remember, though: The downside to making early withdrawals from your Roth IRA is
that less of your retirement money will benefit from tax-free compounding.
The USAA Educational Foundation publication, Making Money Work for You, offers more information on how to
build a sound financial future.
Topics covered in this section are:
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Basic Money Management
Basic Money Management