What are Individual Retirement Accounts (IRA)?

What are Individual Retirement Accounts (IRAs)?

Individual Retirement Accounts (IRAs) are investment accounts designed to help individuals save for retirement with potential tax advantages. As the name suggests, IRAs are established and held by individuals rather than being provided by an employer.

How is a 401k Different from an Individual Retirement Account?

Here are the main differences between a 401(k) and an IRA:

Availability and Sponsorship: A 401(k) contribution is an employer-sponsored retirement plan, meaning it is only available to employees of companies or organizations that offer it. On the other hand, an IRA is an individual retirement account that can be opened and funded by an individual, independent of their employment status.

Contribution Limits: 401(k) plans have higher contribution limits compared to IRAs. For 2023, the annual contribution limit for a 401(k) is $20,500 (or $27,000 for an individual aged 50 or older with catch-up contributions). By contrast, the IRA has a contribution limit of 6,000 (or 7,000 with catch-up contributions) per year.

When Were Individual Retirement Accounts Created?

The Employee Retirement Income Security Act of 1974 added Section 408 to the Internal Revenue Code, creating what is known today as an Individual Retirement Account (IRA). Part I of this BluePrint article reviews some considerations to examine when starting an IRA, which allows individuals to save for retirement with tax advantages, targeting those who may not have access to employer-sponsored retirement plans.

How Does an Individual Retirement Account Work?

A type of retirement savings account that individuals can open and manage on their own, without an employer.

Here’s how an IRA generally works:

Account Setup: To open an Individual Retirement Account, you must first select a financial institution, such as a bank, brokerage firm, or mutual fund company that provides retirement services.
Contribution: You are able to contribute to your IRA up to the amount the IRS allows.
Investment Options: Your IRA is funded; now choose an investment. Depending on your planning stage and goals, you’ll have several investment options to start your account.
Tax Advantages: As if offering another compelling reason to invest in a traditional IRA, contributions may be tax-deductible in the year made and thus reduce your taxable income that year.
Withdrawals: IRA withdrawals are generally penalized if you take them prior to age 59½.
Rollovers and Transfers: When changing jobs or retiring, you can roll over funds from employer-sponsored retirement plans, such as 401(k) or 403(b) plan accounts, into an IRA.
Required Minimum Distributions (RMDs): Traditional IRAs have a rule known as Required Minimum Distributions (RMDs), which says that at 72 (as of 2022), a certain amount must be withdrawn from the account each year.