IRA is the acronym for Individual Retirement Account. It is basically a savings account to build your retirement nest egg with a distinguishing feature : your money grows on a tax-free basis. An IRA can be opened by employed individuals (employees) and their spouses, self-employed people and small business owners. You can set up an IRA at a bank, mutual fund company, insurance company or brokerage. Before we can understand the meaning of IRA in more detail, here is a brief history of this retirement plan.
A brief history of IRAs
The Employee Retirement Income Security Act of 1974 (ERISA) first authorized IRAs with the intention to encourage working individuals to save for retirement. Beginning from 1975, Americans were allowed to open accounts at financial institutions and deduct their contributions from their taxable income. Only employees without a pension plan were eligible to make contributions, with annual contributions being capped at a maximum of $1,500 or 15 percent of pay. IRA eligibility expanded and maximum contributions increased with the passage of the Economic Recovery Tax of 1981. The Taxpayer Relief Act of 1997 and Economic Growth and Tax Relief Reconciliation Act of 2001 further increased the maximum permissible contributions to IRA.
What are the benefits of investing in a IRA?
An important aspect of understanding the meaning of IRA is knowing how setting up one can benefit you.
A 410(k) or other employee-sponsored savings plan may not allow you to stash away a large retirement corpus. An IRA is a reliable way to supplement and grow your retirement income.
You can include just about every type of investment in your IRA. Consider it your retirement portfolio, with the option to save money via any debt, equity or other financial instrument you want. For instance, your IRA can comprise a mix of Certificates of Deposit (CD), stocks, bonds, mutual funds and even real estate. This is in contrast to the limited investment options offered by most 401(k) plans.
The tax-deferred growth offered by an IRA helps you save quite a bit each year on taxes.
Features of an IRA
More details on the meaning of IRA and its basic features are outline below:
1. There is a limit to how much you can contribute to your IRA
For 2015, total contributions cannot exceed :
$5,500 or $6,500 if your age is 50 years or more OR
your annual taxable income, if the income was less than the imposed dollar limit
2. You have to pay taxes on early withdrawals
If you withdraw from your IRA before you hit the retirement age of 59 ½ years, you will need to pay a 10 percent tax penalty. There are some exceptions to the early withdrawal penalty, including higher education expenses, unreimbursed medical expenses, income to support livelihood in the event of disability and for the purposes of purchasing or building a first home.
3. Opening an IRA is easy
You can set up your account directly from an IRA provider’s website or visit a local branch to accomplish the task.
It is best to contribute a maximum amount to your IRA to maximize your savings. It is also important to examine your investments from time to time as you approach retirement and priorities change.