What is an IRA, anyway?

Transcript

What is an IRA, anyway?

IRA stands for individual retirement account. It’s one of many ways you can save money for the future, and its popularity is growing—about one-third of households owned an IRA in 2019.

But how do IRAs work? Great question.

Some people think an IRA is an investment, but it’s actually an account that holds many investments. Your IRA can pack in stocks, bonds, mutual funds, and more. This can give your money a better chance to grow than it would have in a regular savings account.

There are two different kinds of IRAs: traditional and Roth. The differences between them boil down to two important things: taxes and withdrawal penalties.

When you contribute to a traditional IRA, you deduct those contributions from your total income when you do your taxes. Later on, when you make a withdrawal—known in the financial world as “taking a distribution”—you pay regular income taxes on the total amount you take out.

If you wait until you’re 59½ to start making withdrawals, you won’t pay any penalties. Not bad as far as half-birthday presents go, but the wait time can be limiting—if you make withdrawals before that magic age of 59½ , there’s an extra 10{f08ff3a0ad7db12f5b424ba38f473ff67b97b420df338baa81683bbacd458fca} penalty unless you qualify for an exception.

With a Roth IRA, it works the opposite way—you pay income taxes on the money you put into the account, but all your withdrawals later on are tax-free, including any earnings.

Plus, you can withdraw the money you’ve contributed anytime you want without paying taxes or a penalty, so there’s no need to wait for that half-birthday. Unless you were excited about turning 59½, which we understand completely.

No matter what kind of IRA you choose, it won’t interfere with your employer-sponsored plan. That gives you even more freedom to find the right fit.

Visit our resource on the web to learn more and compare Roth and traditional IRAs. When you’re enjoying 59½ and all the years that come after it, you’ll be glad you did.

Important information:

All investing is subject to risk, including the possible loss of the money you invest. 

IRA ownership statistics come from Investment Company Institute’s ICI Research Perspective, December 2019, Vol. 25, No. 10. “The Role of IRAs in US Households’ Saving for Retirement, 2019.”

© 2020 The Vanguard Group, Inc. All rights reserved.