Individual Retirement Account

An individual retirement account (IRA) is a tax-friendly savings account that lets investors save for retirement. There are a few types of IRAs like traditional, Roth, SEP, and Simple IRAs.

Investors can open an IRA at a bank or with a robo-advisor or brokerage. Investors can choose from a variety of stocks, bonds, funds, and ETFs to hold in their IRAs. Most people can contribute up to $6,500 per year to their traditional IRA and deduct those contributions from their annual taxable income if they meet certain requirements. These dollars are taxed once the investor withdraws money from the account. Because IRAs are meant for retirement savings, there is a 10% penalty on withdrawals before the person turns 59 ½. After 72, individuals must make a required minimum distribution (RMD) every year or face a 50% penalty on the distribution amount.

The main difference between a traditional IRA and a Roth IRA is when an investor pays taxes. With a Roth IRA, taxes are paid on the contributions, so investment growth and withdrawals aren’t taxed. The opposite is true for a traditional IRA; taxes are paid on withdrawals. SEP IRAs are created by small-business owners and are like traditional IRAs. The main difference is that business owners control contributions, and employees can’t contribute to these accounts. Simple IRAs are like SEP IRAs, but employees can put money into these accounts.