What is an IRA?

An individual retirement account, or IRA for short, is an arrangement in the United States which offers some tax advantages as far as retirement savings. It is more formally known as an individual retirement arrangement. The IRA was begun through amendments to the Internal Revenue Code (IRC) which were made by the Employee Retirement Income Security Act of 1974 (ERISA). IRC sections 219 and 408 both have items relating to IRAs.

There are several types of IRAs, and each one has unique benefits and uses. The following are glances at each IRA classification:

Roth IRA: Named after Senator William Roth, the contributions to this plan are made with after-tax assets. Withdrawals are often tax free, and transactions within the account do not impact taxes.

Traditional IRA: This type is also sometimes known as a deductible IRA or non-deductible IRA, depending upon whether the contributions to it are in fact tax deductible. Withdrawals are taxed as income, unless the original contributions were not deducted. Transactions within the account do not affect taxes.

SEP IRA: The name is short for: Simplified Employee Pension. Such an arrangement allows an employer to make contributions into a plan in the employee's name, rather than into a pension account under the company's name. This is often used by a self-employed person or small business.

SIMPLE IRA: Its name stands for: Savings Incentive Match PLan for Employees. The account is employer-sponsored in nature. An eligible employer may establish a SIMPLE IRA, and either match employee contributions up to a certain point, frequently 3%, or contribute a flat 2% compensation. Technically, the plan may be funded with either an IRA or a 401(k), however, the IRA is preferred in most cases as there is nearly no benefit to using a 401(k).

Self-Directed IRA: In this plan, the account-holder is allowed to make investments on behalf of the retirement plan. However, a qualified trustee or custodian bank must still hold the assets of the account on behalf of the owner of the IRA. That third party will normally maintain the account's assets and transactions, keep records, file the necessary reports to the IRS, and care for some other items.

Although a particular individual may not be able to use each option, there are various IRA options from which to choose.

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