What is an IRA?
The IRA stands for the Individual retirement account. It is an investment tool used by the individual to earn and save the funds for retirement with tax –free growth or tax-deferred basis. IRAs consist of different financial products like stocks, bonds or mutual funds. In the IRA, the individual taxpayers initiate traditional and Roth IRAs, the small business owners, and self-employed individuals initiate SEP and SIMPLE IRAs.
Pros and cons of IRA:
- Tax-deferred: The funds in this plan are included in a tax-deferred retirement plan account and it doesn’t have any time or age restriction.
- Easy, cheap to start: The plan holders can easily set up their own IRAs. The investors don’t need the financial advisor for planning the investment. So the investors can save time and cost.
- More investment options: The IRA plan holders not only invest in this plan but can also invest in stocks, bonds, and mutual funds, CDs etc.
- More flexible allocation: In IRA plan, the performance of the account can be tracked and have the option to adjust the account allocation if the investor finds out that the account is not performing well.
- Roth IRA option: The Roth is the primary choice if the investor wants to convert the traditional IRA. The contribution made to the Roth is post-tax and it grows tax-free and offers tax-free income at the time of withdrawal. The main advantage is there is no tax on the income.
- Tax deduction: The contribution to the traditional IRA is claimed as the tax deduction and dependent on the policyholder’s income tax bracket.
- Limited contribution maximum: The deposit into this IRA is restricted. The investor is allowed to deposit up to the limited amount.
- Low contribution rate: The contribution to the IRA plan is low. The people who start the IRA plan in later stages of the life. The contribution rate may not be enough.
- Penalties for early withdrawal: The investor has to the penalty to the insurance company for early withdrawal.
- Required withdrawals at the age of 70 1/2: The investor is required to withdraw the money by age of 70 ½.
Type of IRA:
Traditional IRAs: The contribution to traditional IRA is tax deductible. The income tax is not applicable at the time of contribution. But the investor has to pay the tax at the time of withdrawing because it is considered income.
Roth IRAs: The contribution made in Roth IRAs is non-deductible. The contribution is made after-tax amount. So the amount grows in the account doesn’t have taxation for that amount. At the time of withdrawal, the investor doesn’t have to pay any income tax.
SEP IRAs: The SEP stands for simplified employee pension IRAs. This plan is for self-employed individuals like independent contractors, freelancers, and small-business owner. The investor can contribute from the reported business income and secure the lower tax rate on the business income. The investors are not allowed to contribute to their accounts and if done so taxes will be applicable on the withdrawals as income.
SIMPLE IRAs: The SIMPLE IRA is known as savings incentive match plans for employees. It is for the employees of small businesses and self-employed individuals. In SIMPLE IRA, the employees are allowed to contribute to their accounts and the employer is also required to make the contributions. These contributions are tax-deductible, lower tax income.
The components included in the IRA calculator are:
- Current balance: The current balance in the IRA.
- Annual before tax contribution: The annual contribution to IRA before taxation.
- Investment returns: The return on the investment.
- Current age: The current age of the investor.
- Retirement age: The retirement age of the investor.
- Current marginal tax rate: The current marginal tax rate.
- Marginal tax rate in retirement: The marginal tax rate at the time of retirement.
- Inflation rate: The inflation rate of the amount invested.
Using this IRA calculator the investor can easily evaluate and compare the different IRAs and regular taxable savings. By comparing the investor can convert the after-tax values.