What is an IRA Savings Account?

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What is an ira savings account

Do you imagine sipping drinks on the beach and watching the sunset in retirement? Or spoiling grandkids with toys and trips? An individual retirement account (IRA) savings account can help build the retirement of your dreams. It is one more investment tool that allows your money to grow with tax advantages. Anyone with earned income can contribute to IRAs. Learn about the types of IRA savings accounts and why you should open one as early as possible. And keep reading to the end to see how you can get personalized offers from our trusted partners through MoneyLion!

Types of IRA savings accounts

The most common types of IRAs are Roth and traditional IRAs. Self-employed individuals and small businesses may also be able to use a SEP IRA or a simplified IRA. In all types, you’re able to invest in stocks, bonds, exchange-traded funds (ETFs), mutual funds, real estate investment trusts (REITs), and other financial products. Here’s what you need to know. 

Traditional IRA savings account

Any individual taxpayer can open a traditional IRA savings account to save for retirement. With a traditional IRA, all contributions you make are tax deductible. In the majority of cases, you’ll be able to deduct those contributions from your earned taxable income for the year. 

In a traditional IRA, the money grows tax-deferred. When you withdraw the funds, you’ll be taxed at your income tax rate for the year of withdrawal. However, if you withdraw funds before age 59½, you’ll have to pay a 10% early withdrawal penalty plus taxes on the funds withdrawn. Exceptions to this withdrawal penalty include unusual events like medical expenses, disabilities, and first-time home purchases.

In 2023, the maximum amount you can contribute to a traditional IRA in one year is $6,500 or $7,500 if you’re over 50

Keep in mind that IRAs come with required minimum distributions (RMDs) that the owner of the IRA must take by a specified age. As of 2023, RMDs start from the age of 73. If you don’t take the RMD, you’ll be fined a penalty of 25% of the account value. 

Roth IRA savings account

Roth IRA savings accounts offer some of the same retirement savings benefits as a traditional IRA with an important twist: you’ll pay taxes on all contributions to a Roth IRA. The big bonus of Roth IRAs is that distributions are tax-free. That means you won’t pay taxes on the funds when they’re withdrawn in retirement. Roth IRAs also don’t have RMDs, so you can leave them to grow as long as you want. 

Roth IRAs have income limitations for eligibility due to their substantial tax benefits. As of 2023, that’s $138,000 to $153,000 for single filers and $218,000 to $228,000 for married couples filing taxes jointly. 

In 2023, the maximum amount you can contribute to a Roth IRA in one year is $6,500 or $7,500 if you’re over 50 and catching up. 

Simplified Employee Pension (SEP) IRA

A SEP IRA is a retirement savings account for self-employed individuals, independent contractors, and small business owners. SEP IRAs follow the same tax rules as a traditional IRA for withdrawals but have a higher contribution limit. In 2023, the maximum allowed contribution is 25% of compensation or $66,000, whichever is less. 

Business owners can set up SEP IRAs for their employees and deduct contributions they make from business income. Business employees can’t contribute to their own SEP IRA savings accounts. And, like a traditional IRA, they will be responsible for taxes at their standard rate on withdrawals. 

How Does an IRA savings account work?

Ready to open an IRA savings account? Make sure you check contribution limits, tax advantages, and eligibility before choosing the type(s) of IRAs for you. 

Eligibility requirements

To contribute to an IRA, you’ll need earned income. Your IRA contributions can’t exceed your annual earned income. For a traditional IRA, you’ll need to take disbursements from the age of 73 if you turn that age on or after Jan. 1, 2023. For a Roth IRA, there are no withdrawal requirements. 

For all IRAs, you’ll pay a 10% early withdrawal penalty if you take the funds before age 59½. Also, limits exist on the maximum contribution you can make to an IRA each year. 

Contribution limits

As of this year, you can contribute up to $7,000, or $8,000 if age 50 and older, for a traditional IRA or a Roth IRA. For a SEP IRA, you can contribute up to $69,000, or 25% of compensation, whichever is less.

Tax Advantages

The main advantage of Roth IRAs and traditional IRAs is the tax advantage. In the case of a Roth IRA, you’ll pay taxes on the income when you contribute to the IRA but won’t pay taxes when the funds are withdrawn. This means that the funds can grow significantly, and you won’t have to pay taxes on those funds. 

In a traditional IRA, you can deduct contributions from your income to save on taxes upfront. Contributions and dividends are taxed once you withdraw funding, starting with required minimum distributions at age 73. A traditional IRA is a major advantage for many retirees in a lower tax bracket after retirement than they were while earning. 

Investment options

Compared to a 401(k), IRA savings accounts offer a far more diverse portfolio of investment vehicles. You can invest in stocks, bonds, CDs, Treasury bills, savings bonds, money market funds, mutual funds, and ETFs. In contrast, other retirement savings options like a 401(k) usually only allow investment in mutual funds and ETFs.

Withdrawal rules

You must wait until age 59½ to withdraw from an IRA or a Roth IRA without penalties. If you withdraw before that age, you’ll have to pay a 10% early withdrawal. Exceptions are available for special financial situations like medical expenses, the purchase of a first house, 

For a traditional IRA, you’ll need to take the required minimum distributions from a set age (73 as of 2023) or be fined a penalty of 25% of the account value.

Benefits of IRA savings account

IRA savings accounts offer significant tax advantages for retirement planning. Here’s how an IRA savings account can help you reach your goals. 

Retirement planning

The main purpose of an IRA savings account is for retirement planning. While the maximum contributions are relatively small, these contributions can build significantly over the long term.  If you start making contributions at age 30 into a Roth IRA, you could earn over $1 million by retirement.  

Likewise, a traditional IRA allows tax-deferred growth. For high-income individuals, retirement can mean a lower tax bracket and lower taxes on withdrawals. 

Compound interest

IRA savings accounts that are not invested in the stock market use the power of compound interest. That means that earnings are retained in the account, so the earning power of the account compounds over time. While annual contributions remain stable, the compound interest builds up over time. 

Here’s an example. Assuming you were able to earn an interest rate of 7.74%, if you only contribute to a Roth IRA for 10 years with a maximum annual contribution of $6,500, you’ll have $93,000 and have made $65,000 in contributions. If you withdraw after 20 years, you’ll have about $289,000. If you wait 35 years, you’ll have around $1 million. That is the power of compound interest. However, over the past 35 years, interest rates paid by banks have rarely been close to 7.74%.

IRA savings account rates will vary by investment type, market climate, and stock performance.  

Flexibility in investment options

Compared to a retirement investment account with a 401(k), IRAs offer far greater flexibility in investment vehicles. You can choose from stocks, bonds, mutual funds, or exchange-traded funds.  

How an IRA compares to other savings accounts

A savings account holds funds in cash for a lower interest rate, usually far less than 1% to 4% in high-yield savings accounts. An IRA or a Roth IRA can hold funds in most investment vehicles, including stocks, bonds, and funds. 

However, it is worth having several investment and retirement accounts. A high-yield savings account is a good vehicle for more short-term savings, including an emergency fund of three to four months’ salary plus savings goals for which you’ll need the money in the next three to five years.  

Using IRA savings accounts to create a better future

IRA bank accounts of all types are powerful investment tools to create a better retirement. You’ll be able to save substantial amounts on taxes, either in deferred tax payments or in tax withdrawal savings. Along with other savings and investing tools, IRA savings accounts are powerful tools for building long-term wealth. 

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What are the benefits of opening an IRA savings account?

IRAs have significant benefits in tax breaks or tax deferrals. An IRA is also easy to set up and exclusively yours rather than controlled by your employer. It offers retirement security and lots of investments to choose from. 

What types of IRA savings accounts are available?

The main types of IRA savings accounts available are a traditional IRA, Roth IRA, SEP IRA, and simple IRA.

Is it advisable to open an IRA savings account, even if I have a 401(k) plan?

Yes, you can  open an IRA savings account even if you have a 401(k), assuming you’ve already maxed out any employer match options for your 401(k) and meet income limits or other IRS restrictions. It’s worth having several retirement accounts, especially since an IRA has additional tax benefits and additional investment opportunities.  

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