An Individual Retirement Account (IRA) is a tool used to set aside assets and investments for retirement, where your assets can grow in the account tax-free. An individual opens their own IRA with a financial institution, making it different than a 401K account, which is opened for employees by most employers. There are a few different types of IRAs, and each has specific eligibility, distribution, and withdrawal restrictions, as well as a government cap on yearly contributions.
Because you can keep stocks, bonds, and other assets in your retirement account, an IRA is often mistaken for an investment in-and-of-itself. However, an IRA is just the account that holds your investments, and there is little risk associated with opening one. Most of the risks associated with IRAs come from breaching the regulations already in place when you open your account. For instance, choosing to withdraw your assets before you reach your retirement eligibility requirements (sometimes done in the case of an emergency) results in strict, and usually costly, penalties.
The two most common types of IRAs are Traditional IRA and Roth IRA. One main difference between a Traditional or Roth account is when you pay the income taxes on your funds. Traditional IRA funds are deposited pre-tax, and the funds are taxed as income when removed from the account. Roth IRA funds are taxed upon deposit, and therefore can be withdrawn tax-free upon retirement.
Additionally, Roth IRAs have income limitations in order to qualify, but are more flexible regarding distribution and certain types of early withdrawal than Traditional IRAs. For example, a Roth IRA allows penalty-free removal of funds to pay higher education costs or go toward the purchase of your first home. Roth IRAs also allow your account to grow as long into retirement as you like, while Traditional IRAs have a set age level at which you are required to begin withdrawing or redistributing your funds.
Besides the security of earmarking certain assets for your future, the main benefit of IRAs (regardless of type) is that your assets, including any interest or capital gains, can grow tax-free inside the account. An IRA can be an incredibly helpful tool in long-term planning for retirement, and you will earn the most benefits by depositing as much as the government allows (and as much as you are financially able) into your account. However, make sure you understand the terms and limitations of your IRA. If you are saving for an emergency fund or planned future purchase, a high-interest savings account might be a better option.
At Columbia Bank, we know that sorting out the different requirements and terms of each type of IRA can be a confusing process, and somewhat daunting. We offer assistance with both Traditional IRAs and Roth IRAs. Contact Columbia Bank or visit our Investment and Wealth Management Center to learn which type of Individual Retirement Account you qualify for, or to get started in setting up an account!