What Is an IRA?

By Jonathan Bales , last updated May 30, 2011

An IRA is an individual retirement account held at a custodian institution like a bank or brokerage. Established in 1975, an IRA may be invested in anything, which is accepted by the custodian, such as certificates of deposit, mutual funds and so on. The only requirement to be eligible for a Traditional IRA is sufficient income. Contributions to one's IRA are tax-deductible, but these require much more stringent eligibility requirements. Deposits into a Traditional IRA are not subject to federal income tax until money is withdrawn from the account. Transactions within the account, like capital gains, dividends and interest, are not subject to tax liability.

The primary advantage of a Traditional IRA over a Roth IRA is that the former has tax-deductible contributions. A Roth IRA also has much more strict eligibility requirements, although it easier to withdrawal funds than from a Traditional IRA. Another advantage of a Traditional IRA is that a taxpayer can secure an IRA in a specific tax bracket that he may not still be in by retirement. Lastly, there is some concern that Congress may decide in the next few years to tax contributions to a Roth IRA. That will not happen with a Traditional IRA.

The primary disadvantages of a Traditional IRA include the strict tax-deductibility requirements, as well as the taxing of withdrawals. All Traditional IRA withdrawals are included in one's gross income. Holding stocks in a Traditional IRA is a poor idea for this reason, as they lose their favorable tax treatment. For those with a lot of disposable income, a Roth IRA is superior to a Traditional IRA because the latter does not allow the taxpayer to shelter as many assets. A Traditional IRA also forces distributions based on age. One must begin withdrawals by age 70 1/2, while a Roth IRA has no such requirements.

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