Individual Retirement Accounts (IRAs) are tax-advantaged savings accounts for retirement, with different types offering varying tax benefits. Contributions are limited and penalties apply for early withdrawals. People over 50 can contribute more. Similar retirement plans exist in other countries, such as the UK’s Individual Savings Account (ISA).
Also known simply as an IRA, an individual retirement account is a savings account in which the funds are not taxed at the time they are deposited into the fund. The IRA is one retirement funding option in the United States, but it is not unique. Many other countries also have similar retirement plans that carry similar tax breaks, such as the Individual Savings Account, or ISA, which is offered in the UK.
The first individual retirement account was offered in the United States in 1974. Legend has it that the savings plan’s designation as an IRA was actually the recognition of one of the actuaries working on the development of the offering, Ira Cohen. Other sources claim that this was simply a coincidence, or nothing more than an urban legend.
Since the inception of the first Individual Retirement Account, several different types have emerged, each with a slightly different tax benefit. A traditional IRA has the benefit of not incurring taxes on the amount deposited annually, which can reduce a person’s tax burden. Withdrawals from the account are counted as income during the years in which the withdrawal is made. By contrast, a Roth IRA allows contributions to be taxed in the years in which they are made, but are tax-free when withdrawn in subsequent years. Almost all Individual Retirement Account forms come with a penalty that must be paid in case the withdrawals are made before the individual turns 59½.
As a retirement savings plan, the individual retirement account allows workers to set aside a maximum amount of their income each year for deposit into the savings plan. Over the years, the total of that annual contribution has increased, allowing for changes in the economy and standard of living. With the development of different types of IRAs, laws have been established that govern the total amount of annual contributions that establish a maximum amount that can be accumulated in different accounts, assuming that the worker has more than one IRA established.
For example, if the worker has both a Traditional IRA and a Roth IRA, and current regulations allow an individual to contribute up to $5,000 in United States Dollars (USD) annually, the worker could choose to deposit equal amounts of $2,500.00 USD on each of the two accounts. However, the worker was unable to deposit $5,000 USD into each account.
People age 50 and older can contribute slightly larger amounts to an Individual Retirement Account each year. This can be especially important for workers who wait until later in life to start contributing to an IRA, as it allows them to accumulate more reserves in the account than they otherwise would have. Although it is possible to start making withdrawals at age 59½ without incurring a penalty, many people choose to wait until they reach full retirement age, which is 65 in the United States. Ideally, IRA withdrawals can be used to supplement pensions, 401(k) plans, and other retirement plans, thereby limiting the amount of tax assessed each calendar year.
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