What’s an IRA?

Retirement is a time that many of us look forward to, and it's never too early to start saving for a comfortable lifestyle in later life. Sensible financial planning is essential, and employer-sponsored plans won't be enough for many people's needs.

There are various options available for retirement savings, and an IRA is one of the most popular. Understanding what an IRA is and how it works can help you choose the most suitable savings plan for your circumstances.

An individual retirement account (or arrangement) is an account that helps you save for retirement, and it offers some tax advantages. Many people choose to save extra money in an IRA to supplement an employer-sponsored program, like a 401(k).

How Does an IRA Work?

When you contribute money to an IRA, you may be able to deduct it from any tax you owe. There are income limits to how much of your IRA contributions you can deduct from your annual tax bill.

IRAs accumulate cash value on a tax-deferred basis, which means that you don't pay tax on any earnings until you withdraw them. As your tax bracket will likely be lower in retirement when you no longer have a full-time income, you might not have to pay as much tax on the account's growth as you would while still working.

IRAs are only suitable for people who want to save for retirement. It's essential to ensure that you can afford to lose access to your contributions while you're still working because most IRAs don't allow withdrawals before age 59.5. Earlier withdrawals attract a significant tax penalty of 10%, except in specific circumstances such as buying your first home or covering educational costs.

IRA account holders can choose how to invest their savings across various bonds, stocks and exchange-traded funds. Some IRAs allow savers to take complete control over their investment allocations, enabling access to a broader range of investment opportunities. However, many IRA providers restrict access to the riskiest investment options.