Welcome to Money Basics, Yahoo Finance’s new personal finance series offering quick explanations for some of the most important terms involving your money.
An IRA, or individual retirement account, is a tax-deductible investment savings account. You can contribute pre-tax dollars directly into an IRA where it will be invested and can grow tax-deferred over time. Investments within an IRA can range from individual stocks and bonds to mutual funds and ETFs, among other options.
There’s another tax benefit to IRAs as well. Those pre-tax IRA contributions can also be tax deductible, but your income level and whether you have an employer-sponsored retirement plan or not will determine how much of your contribution can be deducted. Check with the IRS to see if you qualify.
There are limits to how much money you can put in an IRA each year. In 2016, taxpayers younger than 50 years of age were limited to $5,500 in contributions a year. Taxpayers over 50 were limited to $6,500 a year.
Once you reach retirement, the money you withdraw from your IRA is taxable. If you withdraw money before age 59.5, you may have to pay an additional 10% tax penalty, although there are exceptions. If you hit age 70.5, you’ll be required to take distributions from your IRA.
As with any investment account, IRAs carry some degree of risk. Depending on your investments within the IRA, it can lose money. For instance, a stock market downturn could negatively impact your IRA if it’s heavily invested in stocks.
IRAs can be a great retirement savings vehicle and understanding how they work can put you on the path to a richer retirement.