If you’ve ever wondered “ what does IRA stand for ?”, then you may be surprised to find out that the IRS defines it as an “individual retirement arrangement”. This is slightly different than the common definition of an “individual retirement account”. Although similar, an individual retirement account is simply one form of the broader range of individual retirement arrangements that exist under the US Publication 590 (the laws where IRA’s come from).
All IRA’s are intended to be a place where individuals can save and invest their money for retirement. This is outside the confines of their employer, which is the difference between an IRA vs 401k. By classifying your account as an IRA, you are granted special tax-exempt privileges (which vary depending on which type of IRA you set up). Those tax breaks are designed to encourage you to save for your future.
Types of IRA’s:
Traditional IRA – A Traditional IRA gives you a tax break up front. This comes in the form of a deduction on your income taxes (which is why it is often referred to as a tax-deferred IRA). Once invested, the principal and earnings grow tax-free. At retirement, you then pay income taxes on the money you withdraw.
Roth IRA – Named after the senator that endorsed it, a Roth IRA is essentially the opposite of a Traditional IRA. You pay your taxes on the money up front when it is first invested. When you do that, you don’t get a tax deduction on your income taxes. Once invested, the principal and earnings grow tax-free. At retirement, you don’t pay anything on the money you withdraw.
SEP IRA – SEP stands for Simplified Employee Pension. This type of IRA allows the employer (typically a small business or self-employed individual) to make retirement plan contributions into a Traditional IRA established in the employee’s name rather than to a pension fund in the company’s name.
SIMPLE IRA – SIMPLE stands for Savings Incentive Match Plan for Employees. This type of IRA is similar to a 401k, but has lower contribution limits and is less complex. It requires employer matching contributions to the plan whenever an employee makes a contribution.
Self-Directed IRA – A self-directed IRA is type of IRA where someone else controls the actions of the account for someone else. Generally the trustee/custodian will maintain the assets and all transaction and other records pertaining to them, file required IRS reports, issue client statements, assist in helping clients understand the rules and regulations pertaining to certain prohibited transactions, and perform other administrative duties on behalf of the Self-directed IRA owner for the life of the IRA account.
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We’re low earners right now, so the Roth is our current favorite!
Tom Gorski says
Hi, thank you for this informative write up. Can you throw a bit of light in to the kinds of IRA that are suitable for a specific job holders, keeping in view, the kinds of jobs they hold?
Tom Gorski says
Hi, thanks for approving my comment, looking forward to some relevant discussions ahead..:)
I’m not much conversant with investment and the terminologies. But hey, thanks to you for bringing this important aspect of retirement investment, IRA in plain English.
A very nice way of summing up the different types of financial IRA’s indeed! Now there’s at least another dozen or more different non banking terms for the acronym IRA to explain!