How an IRA Works

How an IRA Works
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A 401(k) plan gives participants little choice. The company will have selected the fund manager. The fund manager will decide how to invest the employees’ money—and the employees can watch it grow.

Funding an IRA requires initiative from the participant. You can obtain an IRA from a bank or a brokerage or a financial investment firm. They’ll offer you a range of options to suit your chosen level of risk. They’ll contain different amounts of stocks and bonds, and you may even be able to choose a simple savings account that you can use for your IRA, although the interest rate is likely to be relatively low.

Benefits

The benefit is that you’ll have choice. You’ll be able to check performance, take advice and suggestions, and choose the IRA and the investment company you want. You should also find that the fees are lower than they are on many 401(k) plans.

You’ll then be able to put money into that fund on a tax-preferred basis. While the contributions that the company makes to your 401(k) don’t reach your bank account until you retire, you will have to make the payments into your IRA directly from your bank account. You’ll feel the money going out.

But you should be able to write off that contribution as a tax-deduction. Like the 401(k), contributing to your IRA lets you put money away for the future and only pay tax on it when you receive it.

The annual contribution limits, though, are much lower than they are for a 401(k). Annual contributions to a 401(k) can be as much as $19,500 with another $6,500 for people aged 50 and over. Contributions to an IRA are only $6,000, or $7,000 for people aged 50 or over.

Tax Benefits

The tax benefits of those contributions can also be limited. As your annual income rises over $66,000 or $105,000 for couples filing jointly, the value of the IRA deduction falls if you also have a retirement fund at work.
So while an IRA can be a useful way to increase your retirement savings and lower your tax liability, it’s limited and best used in conjunction with a 401(k) plan.

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