You might have heard a lot about individual retirement accounts (IRAs) but know very little about what they are or how they can help you reach your retirement goal. Instead of bogging you down with a whole of lot of technicalities, let's take a look at the basics of the IRA. What do you need to know before you get started? (For related reading, see 11 Things You May Not Know About Your IRA.)
An individual retirement account or IRA is a vehicle set up to help you reach your retirement goals. We've all heard that having all of our financial eggs in one basket is a bad idea. So the Internal Revenue Service (IRS) set up the IRA with similar tax benefits as a 401(k) that you may have at work. It's a good idea to have both a 401(k) and an IRA to remain diversified.

The Limits
The IRS allows you to deposit up to $5,000 per year if you're under the age of 50 and $6,000 per year if you're over 50. These maximums will stay in place for the 2012 tax year but may change in future years. You must also have earned income to contribute to an IRA, but that could include a spouse if you're married.

Two Types
What can quickly turn people off to the IRA is the fact that there are two different types of IRAs. The traditional IRA doesn't require that you pay taxes on your gains until you start taking distributions. (Distribution is the term used to describe the withdrawals you make once you reach retirement age.) The traditional IRA keeps more money in your account over time and that allows the money to compound at a faster rate.

The Roth IRA requires that you pay taxes now, at your current rate, because the money you're contributing was already taxed before you received your check. This allows your earnings to grow tax fee, and if you anticipate being in a higher tax bracket in the future, the Roth is probably your best choice. (For additional reading, see Roth Vs. Traditional IRA: Which Is Right For You?)

With both IRAs there are eligibility requirements. With the traditional IRA, you can only deduct your contributions if your family earnings fall below certain maximums and if you're covered under an employee sponsored plan like a 401(k). According to the Vanguard Group, if your traditional IRA isn't deductible, a Roth IRA is the better choice. With the Roth, your contributions are never deductible and there are income limits. If you're single and make more than $125,000 in 2012, you aren't eligible to open a Roth.

Fact 4: The Costs
In order to open an IRA, you'll need a bank or investment broker. Some of the discount brokers offer no-fee IRAs other than the commissions charged to buy and sell within the account. Other brokers will charge a yearly management fee even if they aren't managing the account for you. Look for a no fee IRA. If you're charged a 1% management fee, that could equate to a 30% lower balance over a 30 year period. So keeping fees to a minimum is key.

Whether it's a Roth or traditional IRA, get started. The money that is sitting in your savings account earning little to no interest could work harder for you in an IRA with safe investment choices. Don't know how to invest the money? Ask a fee only advisor for some help. Many are happy to charge you a one-time fee and a fee for an annual consultation. (To learn more, check out Paying Your Investment Advisor - Fees Or Commissions?)

Related Articles
  1. Investing

    2 Common Ways to Misuse Target Date Funds

    The world of asset classes is just as complicated as taking vitamins. How much should you take of small caps? Intermediate bonds? Emerging market stocks?
  2. Mutual Funds & ETFs

    What Target-Date Funds Can Teach About Investing

    Target-date funds are a popular way to invest for retirement. Here's what they can teach the novice investor.
  3. Stock Analysis

    3 Stocks that Are Top Bets for Retirement

    These three stocks are resilient, fundamentally sound and also pay generous dividends.
  4. Professionals

    How to Protect Retirement and Help Adult Kids

    Parents can both protect their retirement money and help their adult kids. Here's how.
  5. Retirement

    10 Ways to Save Your Retirement: It's Not Too Late

    It's not too late to start saving for your retirement, even if you took longer to start thinking about it and doing something about it.
  6. Investing

    Why Is Financial Literacy and Education so Important?

    Financial literacy is the confluence of financial, credit and debt knowledge that is necessary to make the financial decisions that are integral to our everyday lives.
  7. Investing

    10 Ways to Effectively Save for the Future

    Savings is as crucial as ever, as we deal with life changes and our needs for the future. Here are some essential steps to get started, now.
  8. Professionals

    How to Protect Your Portfolio from a Market Crash

    Although market crashes are usually bad news for your portfolio, there are several ways to minimize losses or even profit outright from market movement.
  9. Retirement

    How Robo-Advisors Can Help You and Your Portfolio

    Robo-advisors can add a layer of affordable help and insight to most people's portfolio management efforts, especially as the market continues to mature.
  10. Professionals

    3 Benefits of Working Longer (and Retiring Later)

    There are many reasons why folks in their 60s may want to keep working until at least age 70. Here are three.
  1. What are the risks of rolling my 401(k) into an annuity?

    Though the appeal of having guaranteed income after retirement is undeniable, there are actually a number of risks to consider ... Read Full Answer >>
  2. How can I determine if a longevity annuity is right for me?

    A longevity annuity may be right for an individual if, based on his current health and a family history of longevity, he ... Read Full Answer >>
  3. How does a Roth IRA grow over time?

    Your Roth IRA account grows over time thanks to two funding sources: contributions and earnings. While your contributions ... Read Full Answer >>
  4. Can my 401(k) be seized or garnished?

    As long as your retirement funds are held in your 401(k) and you do not take them as distributions, your 401(k) cannot be ... Read Full Answer >>
  5. Can my IRA be taken in a lawsuit?

    Whether your IRA can be taken in a lawsuit depends largely on your state of residence and the judgment in question. There ... Read Full Answer >>
  6. Are mutual funds considered retirement accounts?

    Unlike a 401(k) or Individual Retirement Account (IRA), mutual funds are not classified as retirement accounts. Employers ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!