Can someone explain IRA's (retirement) to me in very simple terms?

Question

10 points to the first person to explain in the simpelist terms. I tried to look it up on the internet but because I'm not familiar with banking terms I didn't unerstand what they were talking about.

Answer 1

It's pretty simple, but let's compare it with basic banking first.

Basic banking: You put money in a savings account and it earns interest (that's money the bank pays you for letting them keep your money). Next April 15, you have to pay tax on that interest.

IRA: You put money in the IRA and it earns interest. Next April 15, you don't have to pay tax on the IRA interest.

In fact, you don't pay tax on anything in your IRA until you take money out. (If you take it out before you're 59-1/2, you also have to pay a 10% penalty -- the idea is to keep it till you're old and grey.) And the idea is that when you retire, you may be in a lower tax bracket, so your IRA contribution goes farther. But mainly, you've avoided paying taxes on the interest (the money the bank pays you) for 20, 30, or 40 years; instead, that money goes back into your retirement fund.

But wait! There's more! Not only does the money you put into your IRA earn interest without you having to pay taxes on it till you take it out -- it can ALSO reduce your taxes NOW, and it can do it at the last minute. Let's see how this can work.

Imagine it's April 15, 2006, and you're doing your 2005 taxes at the very last minute, like most of us. If you have some cash lying around, you can deposit it in an IRA on April 15, and then you can subtract the amount of money you deposited into the IRA from your total yearly income for 2005 -- up to $2000. Then, the IRS taxes you for 2005 on the new, lower amount.

If you're right up near the next highest tax bracket, depositing money to an IRA can save you a lot right now as well as saving money for your retirement.

If you've got a copy of, uh, A Popular Personal Finance Software Package (just to avoid any conflict of interest/potential spam issues), there's a nifty Retirement Planner in the one I'm thinking of that will let you QUICKly ENter the data and it will just as QUICKly ENable you to see how this can work for you.

Oh, and some of the other answers above aren't correct. You CAN deposit after-tax dollars into an IRA (pre-tax dollars go into a 401k, which is an even better deal, but your employer has to offer the program at work). There's also a variation on the IRA called the Roth IRA, but let's not confuse things. This'll get you started, and if you can get to the Retirement Planner I mention, you'll see some numbers that will astound you.

Answer 2

Alright, here it is, real basic:

An IRA is an account for retirement. You put money into and it grows. What makes it special is that it grows tax-free! The bad part is you can't take it out of the account without penalties until you're a certain age -- like 65.

There are 2 kinds of IRA accounts.

The traditional IRA is where you put in money and get a tax break for whatever you put in. When you take the money out after you've retired, you have to pay taxes on it at whatever tax bracket you're in. The idea is that since it's growing tax-free, the money can grow a lot more. And there's also the idea that your tax rate might be lower after you retire because you won't be earning a paycheck any more.

The Roth IRA is where you put in money but you don't get a tax break. After you put the money in, it grows tax-free. Here's the neat part: when you retire, you can pull out the money tax free! All those years the money was growing, you were making free money!

Because the money will grow by a lot over the years, the Roth IRA is considered the best option for most people. For example, let's suppose you're 25 years old and you put $2,000 into an IRA account. It sits there and grows maybe 10%. By the time you retire at 65, it will have grown to over $82,000! Now would you rather have that tax free or would you rather pay taxes on that?

Hope this explanation was simple enough to help you.

Answer 3

IRA stands for independent Retirement Account. It is an account that is set up for saving your money for retirement. The main advantage is that any interest or dividends earned by your money are not taxed as income. The down side is that, under most circumstances, you cannot withdraw the money before you retire. If you do, you will pay penalties. There are different types of IRAs. Each has certain rules or conditions if you want to withdraw your money before retirement. Some allow for one time withdrawls to buy a home. Some do not allow any exceptions. When you go to the bank they can explain it to you. Also, if you do not understand the person at the bank, do not be afraid to tell them you do not understand and they need to explain it another way. Its your money. If they cannot explain it clearly, try mutual fund companies like Vanguard or Fidelity. They are on the net.

Answer 4

Helo. I've been scouring the internet looking for a simplified answer to your question and hope the following will assist you in understanding the basics of what is an IRA:

Investing : IRA




IRA
The Basics of IRAs

An Individual Retirement Account (IRA) is one of the most common types of personal retirement plans. The government designed IRAs back in 1981 as an incentive to help encourage individuals to save for retirement. By 1987, IRAs had lost their simplicity as "tax shelters". Lawmakers added restrictions that eliminated deductions for many taxpayers. Only three years ago, Congress wielded it's heavy hand again -- this time creating a new type of super-IRA that offers greater benefits than previous versions.

The Basics

IRAs are not actually investments -- they are really just protective shells that shield your money from the IRS. The tax code specifies how each type of IRA should be treated. You specify what type of investments belong in the shell. IRAs are known as defined contribution plans. You know exactly how much you've put into the plan, but you never really know what it will be worth down the road.

The concept of an IRA is relatively simple. You contribute up to $2,000 a year into an IRA account. Earnings that result from your investments will not only be reinvested but will also grow tax-deferred until withdrawal (tax-free for Roth IRAs). This tax-deferred status means your money will compound at a faster rate over the years resulting in a greater payout. The power of a IRA tax shelter will put you well ahead of a non-IRA type of account

Answer 5

IRA stands for individual retirement acount.

I am going to explain a generic IRA ( not a Roth IRA or non-deductible IRA).

It is sort of like a savings account that you can put money into from your paycheck before you pay taxes, but the beauty of it is compound interest. (Compound interest is fancy, so I am not gonna explain that....just the IRA.)

Let's use some hypothetical numbers. You work 40 hours in one week and make $10/hr. Your check would come out to $400 before taxes.

Before taxes are removed, you can contribute a percentage to your IRA. Let's say it's 5 %. So in this case you would have deposited to your IRA account $20. ($400 x 5 % = $20)

Since you deposited $20 to your IRA in pre-tax dollars. Your new check amount would be $380. (This is the $400 minus the ira contribution $20).

So now payroll figueres out your taxes based on you making $380 bucks versus $400.

Let's say payroll tax is 20%.

With IRA contribution: $380 x 20 % = $76 (the tax you pay)
Your take home ($380 - $76) = 304.

Without IRA: $400 x 20% = $80 (this is the tax you would pay)
Your take home: ($400-80) 320.

Now here's the magic. If you did the IRA, you didn't have to pay taxes on the amount you deposited to your IRA account. Therefore you are "deferring your taxes". You have saved $20 towards your retirement. You gain interest on this money if your IRA company invests it well. You can deduct the money that you contribute to your IRA from your taxes.

Another key point, you shouldn't withdraw this IRA money until you are retiring age (usually 65). You can withdraw it earlier but you will have to pay a penalty, thus loosing money.

You cannot deposit money directly to your IRA. It must be pre-tax dollars. There is an annual maximum of how much you can contribute but it changes as laws change. If your employer matches you for how much you put in your IRA take advantage of that free money.

Any money you make in your IRA (investment interest) won't be taxed until withdrawl.

Hope this helps.

Answer 6

An IRA is basically a way to defer your taxes until you retire. You put money in pre-tax and it grows until you are ready for retirement. You still pay taxes when you take your money out but you will most likely be in a lower tax bracket and your investment hopefully has grown.

Answer 7

once the money is in the ira, if you aren't of retirement age and you need to withdraw in an emergency, you will have to pay the federal gov't a penalty of (i think) 10 percent