What are Individual Retirement Accounts (IRA)?
Individual Retirement Accounts (IRAs) are investment accounts designed to help individuals save for retirement with potential tax advantages. IRAs are established and held by individuals, as the name suggests, 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 generally have higher contribution limits than IRAs. In 2023, the annual contribution limit for a 401(k) is $20,500 (or $27,000 for individuals aged 50 or older with catch-up contributions). In comparison, the annual contribution limit for IRAs is $6,000 (or $7,000 for individuals aged 50 or older with catch-up contributions).
When Were Individual Retirement Accounts Created?
Individual Retirement Accounts (IRAs) were created as part of the Employee Retirement Income Security Act (ERISA) of 1974. The purpose of IRAs was to provide a way for individuals to save for retirement with tax advantages, especially for those who did not have access to employer-sponsored retirement plans.
How Does an Individual Retirement Account Work?
An Individual Retirement Account (IRA) is a retirement savings account that individuals can open and contribute to on their own, independent of an employer.
Here’s how an IRA generally works:
Account Setup: To open an IRA, you need to choose a financial institution, such as a bank, brokerage firm, or mutual fund company, that offers IRA services.
Contribution: You can make contributions to your IRA up to the annual contribution limit set by the IRS.
Investment Options: Once your IRA is funded, you can choose from a variety of investment options based on your risk tolerance and retirement goals.
Tax Advantages: With a Traditional IRA, contributions may be tax-deductible in the year they are made, potentially reducing your taxable income for that year.
Withdrawals: IRA withdrawals are generally allowed penalty-free after reaching age 59½.
Rollovers and Transfers: You can roll over funds from employer-sponsored retirement plans, such as 401(k) or 403(b) plan accounts, into an IRA when changing jobs or retiring.
Required Minimum Distributions (RMDs): Traditional IRAs have a requirement called Required Minimum Distributions (RMDs) that mandate the withdrawal of a minimum amount from the account each year after reaching age 72 (as of 2022).
Also, See: Fringe Benefits