What Is An IRA And What Are The Different Types?

By Doug Fretton
Updated March 28, 2015
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What Is An IRA And What Are The Different Types?A popular question among new investors who want to start preparing for their retirement is, "what is an IRA and what are the different types?" In the US, "IRA" refers to individual retirement account. If you open an IRA with a brokerage firm, you can then deposit money into that plan and invest in bonds, mutual funds, stocks, real estate and more. There are numerous different kinds of IRAs which come with their own particular tax rules, pros and cons. If you're wondering about the same question on "what is an IRA and what are the different types," here are some of the most common forms for you to consider.

Traditional IRAs

A traditional IRA is perhaps the oldest type of individual retirement account available. You simply contribute cash to a plan, and receive a tax deduction. Any money that is placed into your account will be protected from taxes until it is withdrawn, potentially decades into the future. This allows you to retain your interest income, capital gains and dividends without having to send any money to the IRS. When you retrieve money from a traditional IRA, you will pay taxes on it as though you were obtaining a paycheck. However, note that if you access the money before you are 59 years old, you will be required to pay a penalty tax of 10% as well as the other taxes you owe. Another important thing to note is that you must start to take out withdrawals from your account when you reach 70 years of age.

Roth IRAs

These individual retirement accounts were introduced as a result of the Taxpayer Relief Act in 1997. The Roth IRA is sometimes considered to be a better deal than a traditional IRA, as you contribute cash to a plan, but do not receive a tax deduction at the time of that contribution. With a Roth IRA, you can begin to withdraw money from your account when you reach 59.5 years of age. What's more, you don't have to pay any money in taxes on the wealth that has accumulated within your Roth IRA. However, the downside of a Roth IRA is that it does come with income limits, and not everyone will qualify. Because the limits change on an annual basis, you will need to check with the IRS to learn more.

SEP-IRAs

The SEP-IRA stands for a simplified employee pension individual retirement account. These generally come with more complex rules, and are used regularly by self-employed business owners, following the same features as a traditional IRA. However, the contribution limits for a SEP-IRA are generally much higher.

When answering the question "what is an IRA and what are the different types?" it's worth noting that you can have more than one. You can have a simple IRA or SEP-IRA on top of your traditional or Roth IRA if you want to. However, you will need to speak to an expert tax accountant to calculate what your contribution limits will be. This professional should also be able to help you find out what the maximum amount of tax shelters you could qualify for.





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