What is an IRA? IRA stands for Individual Retirement Account. It enables an investor to save for retirement while reaping a myriad of tax benefits. These benefits range from obtaining a deduction on the money you save to compounding your money tax-free for decades. Recent changes to the tax laws have raised contribution limits, making IRAs even more attractive investment opportunities, so be sure you are maximizing your contributions. Traditional IRAs allow investors to make tax-deferred investments. While contributions are often tax-deductible, all withdrawals on Traditional IRAs are taxed, and early withdrawals are also subject to a penalty tax. First offered in 1997, Roth IRAs allow taxpayers (subject to certain income limits) to invest for retirement and allow the savings to grow tax-free. Investors pay taxes on their Roth IRA contributions, but withdrawals, subject to certain rules, are not taxed at all.
Contribute early —and often: If you were to contribute $2,000 each year for 30 years: Value with an IRA = $297,150 Value with a taxable account = $183,290 Difference = $113,860 This example shows the benefits of tax-advantaged growth in an IRA — a total of $113,860 more over an identical investment. Our example assumes a 28 percent tax bracket and an earnings growth rate of 9 percent annually. Note that earnings and deductible contributions withdrawn from a Traditional IRA will be taxed upon withdrawal.
Mellody Hobson, president of Ariel Capital Management in Chicago, is GoodMorning America's personal finance expert. Click here to visit her Web site, Ariel Mutual Funds.com. Ariel associate Matthew Yale and Ariel's Director of Corporate Communications Anne Roche contributed to this report.