Individual Retirement Accounts, known as IRA’s, are basically a savings plan for retirement. Created by the government in 1981, the IRA was designed to help individuals save money and provide them with an incentive to put money aside for their retirement. When the IRA was released, it offered tax advantages to those who chose to participate in this new style of investment vehicle. During the years since its inception, the IRA has gone through a number of changes that have impacted its inherent tax advantages and the eligibility of those who would participate. This article offers a brief overview of how today’s IRA’s work and why they may still be the perfect investment vehicle for your retirement.
Benefits Of An IRA
The primary benefit of an IRA is the tax advantage it offers. Money that is contributed to an IRA is allowed to grow while enjoying a tax-deferred status. That is, the taxes on any capital gains made from the investments within the IRA are deferred until the IRA is distributed. As a result, the IRA account is allowed to grow at a faster pace than would otherwise be possible if the capital gains were taxed each year. The effect of compound interest in a tax-deferred investment can be dramatic.
A secondary benefit of an IRA is that the money that is contributed to the IRA is often tax deductible from your taxable income for the year during which the contribution is made. So, even though you earned the money as income during the year of contribution and the money is still working for you as an investment asset, you may not have to pay taxes on the portion of your income that you contributed.
Is It Too Early To Invest In An IRA?
Typically, younger people have the most benefit to gain from setting money aside in an IRA. The younger a person is, the more significant the effects of compound interest on a tax-deferred investment. That is, a person contributing to an IRA each year from age 21 is likely to see more dramatic impact from compound interest on tax-deferred capital gains than a person starting at age 50. However, the tax-deferred status of the capital gains in an IRA make investing in an IRA worthwhile regardless of age.
How Can Your IRA Be Invested?
While some think that IRA’s can only invest in CDs, bonds and other conservative investments, this is actually not the case. Assuming that your tolerance for risk is high enough, you can invest in stocks and mutual funds within your IRA if you wish. In fact, the effect of compounding on tax-deferred capital gains can be far more dramatic when an IRA is invested in stocks and other securities-based investments. So, there is no need to avoid participating in an IRA if you would like to take advantage of growth-oriented investments. You can easily do so within your IRA.
Though people are often intimidated by IRA accounts because they perceive them as complicated, IRA’s are actually simple. They are a great way to save money for retirement and they offer special tax advantages that are not otherwise available to you. Further, you can invest in most growth-oriented, securities-based investment vehicles within your IRA. Remember, the earlier you begin investing in an IRA, the greater impact the compounding effect will have on your tax-deferred capital gains.