Author Topic: What is an IRA - On a Basic Level ?  (Read 2485 times)

zenyata

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What is an IRA - On a Basic Level ?
« on: October 08, 2014, 07:21:42 AM »
This is probably an embarrassingly simple question but I'm not exactly sure what an IRA actually is - i.e. fundamentally what is it and what is the actual account composed of ?   Is it more like a standard bank account that pays an interest rate that adjusts according to various economic factors or is it more like a fund / collection of funds that consists of shares of various stocks etc. ?

I'm primarily asking because it's not clear to me whether an IRA is something where you just contribute the max amount of money you can into it each year and then it just does its thing or whether it's a potentially much more active process akin to a 401(k) where you can choose various funds and your choices can vary depending on what entity (bank, on-line financial institution) you open the IRA through etc.

Thanks for helping enlighten me !

Gin1984

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Re: What is an IRA - On a Basic Level ?
« Reply #1 on: October 08, 2014, 07:22:41 AM »
A tax law/account.  Depending on where you open it, it can be a savings account or a brokerage account.

GardenFun

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Re: What is an IRA - On a Basic Level ?
« Reply #2 on: October 08, 2014, 07:41:00 AM »
It is an Individual Retirement Account.  Focus on the Retirement aspect - its primary purpose is to provide money during a future timeframe that is decades away (for most people).  More time = ability to take more risk. 

Items that eat away at your IRA value:

High fees (expense ratios of 0.5% or greater)
Low risk (low returns from CD's, money market investments)
Inflation (running at 2% so any return consistently less than 2% is causing you to lose money). 

These reasons are why most people invest IRA money in stock index mutual funds with companies like Vanguard or Fidelity vs. purchasing an IRA through a bank.

You can choose to put all your IRA money in 1 fund, or spread it over multiple funds.  Think of your 401k/IRA as working together, instead of separate entities.    Say your 401k has access to a Large Cap index fund (S&P 500-based), but the international or small cap funds offered in the plan are actively managed, therefore they have a large expense ratio (0.5% or higher).  Invest your 401k solely in the Large Cap index fund, then use your IRA to invest in an international or small cap index fund. 

Cheddar Stacker

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Re: What is an IRA - On a Basic Level ?
« Reply #3 on: October 08, 2014, 09:49:58 AM »
An investment account that provides tax benefits.

Traditional IRA =  Tax deduction now and you pay taxes on the amounts you withdraw later.
Roth IRA = Pay tax now and you pay no taxes on the amounts you withdraw later.

frugaliknowit

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Re: What is an IRA - On a Basic Level ?
« Reply #4 on: October 08, 2014, 11:55:03 AM »
You might think of it as a form of an account or the form in which an account is held, rather that an instrument of some sort.  Almost anything can be an IRA:  Bank Deposit, Brokerage Account.

epipenguin

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Re: What is an IRA - On a Basic Level ?
« Reply #5 on: October 08, 2014, 12:06:00 PM »
I think of it as a bucket into which I can put money.

Within that bucket, I could have cash, or stocks, or bonds, or a mixture. And I could store that bucket at a bank, or at a mutual fund company.

If you hold it at a bank, and only put cash in there, then it would be more like a standard bank savings account. You'd earn some (low) amount of interest, which would grow tax-free until it is time to take the money out in retirement. With a regular bank savings account, you declare your interest to the IRS as part of your earnings each year. With an IRA you don't have to pay tax each year. But if it's a traditional IRA you have to declare the amount of money you take out as income, and pay tax at that point. If it's a Roth IRA, the withdrawals are tax free as you used after-tax income to fund it.

If you hold it at a mutual fund, you can put the money into various funds, and it would operate very much like your 401k.

zenyata

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Re: What is an IRA - On a Basic Level ?
« Reply #6 on: October 08, 2014, 03:14:46 PM »
Thanks everyone for the clarifications - was just what I was looking for...

Does anyone have any particular recommendations / testimonials as far as banks / brokerages that would be better than others for opening an IRA  ?

-zen