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Individual Retirement Accounts – IRA

Mar 17th, 2008 by Kenny

Debt is closely tied to savings – the more you do the first, the less you have left over for the latter. Conversely, the more savings you have, the less you (usually) need or want to borrow. Since you’re paying out interest by borrowing, and (in some cases) simultaneously not getting interest by saving instead, you get a double financial whammy.

For example, instead of borrowing money by using your credit card, you could save that same amount every month until you had enough to buy the item you used the credit card to purchase. Only you can decide whether having the item today is worth paying the extra amount of money it cost in interest to own it.

But when it goes beyond individual items, into the realm of saving for retirement, you have a bigger issue to consider. An IRA (Individual Retirement Account) allows you to set aside money for your later years. That has multiple benefits and a few risks.

When you save that money, obviously, you are not spending it. You accumulate interest on that money saved, which compounds over time. See one of the many online calculators to get a feel for how compounding can help, for example, turn a few thousand into many thousands over 30 years. You also get a tax benefit, since by design any money put into the account represents a tax deduction.

Instead, you are taxed on that money when you begin to use it many years later. The theory is that you will then be at a much lower tax rate and therefore pay a much smaller amount than you would when it was first earned. Sometimes that theory is true in practice, and in some smaller number of cases it’s not. You will need to make some predictions for your own case, but for most people it’s true.

There are more variations today on basic IRAs than there were 20 years ago when the idea first became a reality. But the basics remain true. You can still put up to $2,000 per year tax free into the account.

One variation, for example, is the popular Roth IRA. Federal regulations allow tax-free withdrawals as long as the contributions remain in the account for five years and you are at least 59½, or it’s used for a first-time home purchase.

Another common savings instrument is the 401k, named after a provision in the 1978 Internal Revenue Code. These allow employers to put money that is tax-deferred into an account on the employees behalf. You pay no income tax on the money until it is withdrawn.

Those who have difficulty summoning the willpower to save often find these helpful, since it’s allocated before you see your paycheck. Here again there are numerous variations around today.

These and other savings methods can form part of a total financial plan that involves borrowing and investment in many forms. The more options you learn about, the better plan you can develop to maximize your hard earned dollars.