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5 Step Guide to Understanding IRAs

Retirement planning is a mystery for many Americans. If you’re like us, you know all too well how easy it is to let your eyes glaze over when someone starts talking about stocks and shares, 401(K)s and IRAs. Unfortunately, knowing what these terms mean and how to best plan for your retirement is part of being a modern grown up. Here’s a handy five-step guide that explains the basics in just a few minutes.

What is an IRA?

IRAs are Individual Retirement Accounts, or private accounts that you contribute to on your own, in order to save money for retirement. The money you contribute is then split up into stocks, bonds, mutual funds, and other assets, so that it grows for you until you need to withdraw it. The big advantage to IRAs is that your money is deposited before tax, which is a bit like getting an additional 33% on each dollar you save.

Know the Benefits of IRAs

The other benefit of an IRA is that your money grows tax free. This allows the money that you’re saving each year to work for you until you need it, instead of sitting stagnant in a savings account or bond. Your IRA is separate from the 401(K) plan you may have through your employer, allowing you to set aside extra money for retirement. Some IRAs are also available to small business owners and the self-employed, where a 401(K) may not be.

Learn About Traditional IRAs

Traditional IRAs are available no matter your income. The money that you put in the IRA is taxed when you withdraw it, which you must start doing by the time you’re 70 1/2. Most IRAs have a maximum contribution of $5,000 per year.

Learn About Roth IRAs

Roth IRAs have income limits. The money that you add is taxed when you deposit it, and withdrawals must begin by the time you turn 70 1/2. Roth IRAs are available to the self-employed.

Know When to Contribute and When to Withdraw

Your IRA is designed to supplement your other savings, such as your 401(K). There’s no employer matching on these plans, and they typically cap at a $5,000 contribution per year. For this reason, it’s wise to begin contributing to this type of plan as soon as possible, so that your money has time to work for you.

Once you’ve invested your money in an IRA, there are typically steep penalties for withdrawing it before retirement age. Some exceptions to these penalties may include: paying for college expenses, purchasing a first home, medical expenses that eat up a large portion of your income, or a disability.

Before you decide on an IRA, speak to a financial planner to discuss your options. He or she will be able to advise you of the investment choices that are available in your area, as well as the best approach for you to save for retirement. Retirement options will vary depending on your working arrangement, income, health and other factors, which a professional will be able to help you sort out. Happy saving!