An Individual Retirement Account, otherwise known as an IRA, is a type of savings account that gives a tax-deferred or tax-free way of saving up in preparation for retirement. IRAs come in many different types that depend on the various financial objectives of each individual and also their different personal and financial situation. But the most common types are the traditional and Roth IRAs.
A traditional IRA gives the individual the ability to make tax-deductible contributions that can amount up to $4,000 a year. This can increase if the individual is over the age of 50. Any contribution towards the IRA will come from the yearly income, which also reduces the total tax liability. But it should be taken into account that money withdrawn from an IRA will be subject to standard income taxes and there will also be an additional penalty of 10 percent if the money is withdrawn by the account holder before he is 59 and one-half years old. The exception will be if the money will be used to purchase a house or to spend on approve higher education expenses. In this case, the income tax will still apply but the ten percent penalty will not be imposed.
Roth IRAs began in 1997 as a way of helping Americans who belong to the middle class. Roth IRAs are not tax-deductible but give account holders more flexibility compared to traditional IRAs. For example, contributions to the IRA can be withdrawn anytime without any penalties or taxes, although the interest that is earned is still taxed. After five years, the contributions and the earnings can be withdrawn without penalty or taxes.