The Basic of IRAs By Ruth Brock, Regional Extension Agent, Blount County

Most likely you are familiar with 401(k)s, but you may not be as familiar with Investment Retirement Accounts or Arrangements (IRAs). Read on to learn more about two types of IRAs, traditional and the Roth, named for the late Senator William Roth of Rhode Island, who proposed it.

With a traditional IRA:

• Contributions are tax deductible, depending on your income level.
• Withdrawals begin at age 59-1/2 and are mandatory by 70-1/2.
• Taxes are paid on earnings when withdrawn from the IRA.
• Funds are for purchasing a variety of investments such as stocks, bonds, certificates of deposits, etc.
• Opening an IRA account is available to everyone with no income restrictions.
• All funds withdrawn, including principal contributions, before age 59-1/2, are subject to a 10 percent penalty (subject to exception).

With a Roth IRA:

• Contributions are not tax deductible.
• There is no mandatory distribution age.
• All earnings and principal are 100 percent tax free if rules and regulations are followed.
• Funds are for purchasing a variety of investments such as stocks, bonds, certificates of deposits, etc.
• Accounts are available only to single-filers making up to $95,000 or married couples making a combined maximum of $150,000 annually.
• Principal contributions can be withdrawn any time without penalty (subject to some minimal conditions).

The type of IRA that works best for you depends on many factors such as your age, whether or not you contribute to a qualified retirement plan at work, etc. In order to make the best investment decision, refer to IRS Publication 590 or check with your accountant or financial advisor to discuss your particular situation.

Where do you open an IRA?

You have four options when it comes to opening an IRA: a bank, a brokerage, insurance company, or mutual fund company. Shop around for the lowest fees since high fees can hurt your return on the investment.

Bank
A bank might work well if you cannot decide where to put your money. It can also be a good choice if you do not have much to invest. You can often open an account for as little as $100. Most banks allow you to invest in CDs or money market accounts without an annual fee.

Brokerage firm
For the more experienced investor, you might open your IRA at a brokerage firm where you can select your own mix securities or choose from thousands of mutual fund options.

Insurance company
If you open your IRA with an insurance company, you may end up in a fixed or variable annuity. Insurance companies manufacture these products. A fixed annuity is low risk and a typical return might be 6-7 percent, depending on market conditions. Due to higher fees, the net returns to investors are not quite as good.

Mutual fund company
If you are new to investing in IRAs, mutual funds are probably the simplest option. With mutual funds, you can leave the stock picking to the pros and spread your money and your risk across a large number of investments. Look for a mutual fund company with a broad choice of funds. Consider starting with just a single fund. Many funds require a minimum initial investment of $1,000 or more. If you choose to buy individual securities for your IRA, you have to pay a commission on trades. For mutual funds, shop among no-load, no transaction fee funds so you do not have to pay a commission in addition to the underlying expense ratios.

As more and more Americans are concerned about the future of Social Security, contributing to an IRA can contribute to a more financially secure retirement.

References

Garman, E. Thomas, and Raymond E. Forgue. (2006). Personal Finance. New York, NY: Houghton Mifflin Company.

Internal Revenue Service. (2007). Individual retirement arrangements. Topic 451. Retrieved March 3, 2007.

Internal Revenue Service. (2005). Individual retirement arrangements. Publication 590. Retrieved March 3, 2007.

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