What's an IRA?
 

Sorry if this is too elementary, but I searched through other threads and didn't really find anything that tells me what an IRA is. I know that it's for retirement and that I'm not supposed to touch it for years and years. I'm 20 now, and I'll be making a few thousand from my internship this summer to invest in something like this, but I don't really know the difference between an IRA, a CD, a money market account, etc. For instance, are these all funded privately or are there investment opportunities backed by the government (besides government bonds)? Which ones are safer to invest in? What are the time frames involved? The last opportunity I had to learn any of this was my high school economics class, and that wasn't very helpful. Thanks.

I'm sure someone will correct me if I'm wrong, but here is how I understand it:

IRA - retirement account..put money in now, don't touch it until you retire or you have to pay penalties. You find an investment firm and set up your IRA. they pool your money and invest in stocks and bonds. You get money when those stocks and bonds go up, you loose money when they go down.

CD- Certificate of Deposit. You give the money to a bank for a pre determined amount of time and a preset interest rate. The bank invests the money and as long as the stocks/bonds do well, you get the interest. If they don't, you loose money. You can get the money if you need it, but you get penalized.

Money Market Account - like a limited savings account. You will earn interest, but not as much as in a CD or IRA. You have access to your money and can make a certain small number of withdraws in a given time period before incurring penalties. Something like 3 a year maybe.

Hope this helps. Again, if I'm wrong, I'm sure someone will correct me.

Well, IRA stands for Individual Retirement Account. Basically, it is specific money set aside for retirement. From that point, however, all the other products come into play. Once you have set aside money, you can then choose what "vehicle" you want to put it in. CD's, Stocks, Bonds, Money Market accounts, ect. are all options. There are also two main types of IRA's, Traditional and Roth. Tradtional IRA's are accounts where the money is put into it before taxes are taken out. Roth IRAs are post-tax dollars. I would suggest a Roth if you have no current IRA funds, but it would be up to you to find out what would be best suited for you.

Other than that, hrdwareguy did a fine job describing those products.

It will make things a lot less confusing for you if you keep in mind that it is the actual money, not specifically the account, that is tagged for retirement. Basically, your IRA funds are mobile, you can switch what vehicle they are in.

One other thing to keep in mind is that although the money is generally used for retirement, there are exceptions that you can withdraw from the account(s) without penalty. One of the more popular exceptions is a first-time home purchase. If you think about it, it can be hugely advantageous. Let's pretend you have a 401(k) plan that matches 100% of what you put in up to a certain percentage. If you put $5,000 pre-tax into an account, you will have $10,000.00 for a down payment. There are many laws limiting it, but check into them if you are thinking of buying a home...

Irish Republican Army

Oh sorry. Still in Tilted Politics mode. Let me adjust here to Tilted Finance.

Individual Retirement Account

Re: What's an IRA?
 

Bank accounts are backed by the US government, up to $100,000 from theft losses. Investment losses you're on your own. I think that might be one of your questions.

If you're in college (sounds like you are), just put it into a money market fund. You'll probably blow it on beer and chicks anyways, and a MMF keeps it fairly liquid, and is low-risk.

I've never been too fond of CDs. They are low-risk, low return, and your money is locked up tight for a while.

Although starting young with an IRA will do wonders (consider how much $2,000, growing tax free/deferred at 8% over 40 years will look like....now think of doing this every year for the first 10 years, stopping at 30, and just letting it sit there.....) it does tie up your money.

Government bonds you can get into and out from fairly easily, especially if you have a bond fund. Watch out, though. When interest rates rise, the market value of bonds plummets.....and considering that the interest rates are near record-lows....you can do the math. Personally, I'd stay away from those unless you buy bonds near maturity and expect to hold them until redemption. Government bonds with tax-free interest won't do you much good, since it sounds like you're in a low tax bracket anyways (college).

Don't be unreasonable. The best long-term after-inflation returns I've seen from "generic" investment strategies are in the 3-5% range. And if you aren't playing with inflation-adjusted dollars, you are cheating.

Are American non-Roth IRA's simular to RRSP's in Canada?

Description of Canadian RRSP's:
RRSP's in Canada don't get taxed as they grow. You get a tax deduction when you put money into them, and you pay taxes on them when you take the money out. Investments allowed in an RRSP are restricted somewhat (so you can't "invest" in a car you drive around).

There is a limit on how much money you can put into your RRSPs as a fraction of your income, and a hard annual cap as well. You can carry over RRSP room from year to year until you use it. Removing money from an RRSP does not give you the contribution room back, and it is taxed as income.

Yakk -

Indeed, they sound similar, but the money in an American "traditional" (non-roth) IRA is pre-tax dollars, so money that has not been taxed yet. If you prematurely take out the money here, you are not only taxed on the dollars you take out, but you also are required to pay a penalty ( I believe 20%) to do so. However, there are certain "qualifying" reasons to withdraw the money prematurely and not pay taxes or get penalized. Buying your first home, medical expenses, ect are included in those "qualifying" reasons.

Since you're Canadian though, you probably don't need to worry about the medical expenses :D

Pre-tax or getting a tax deduction (income deduction, more precicely) is the same thing, different pile.

Is there any limit to how much money you can put into an IRA?

Yes. There is both an limit on % of income and a hard cap, if I remember correctly.

I think it is 11% of your income annually. But you can get around it with deferred compensation, etc.

I don't understand. If an IRA can be any kind of investment "vehicle" then how can there be a single cap? Does that exist because you officially designate it an IRA with the investment firm you're using? If so, how do you do that? And who imposes the cap?

I suppose for now, all I'm looking for is some kind of account that I can store a chunk of money in that I won't touch except to add to periodically with practice student loan payments. I also want to be able to watch it online like I do my savings and checking accounts. My first instinct was to start a money market account through Citibank because I already have a savings account there and I can transfer my funds into it easily. Then my sister started talking IRA and I wanted to investigate further. I don't want to settle for something less than optimal just because I didn't know any better. Was my first instinct stupid?

(Thanks for all the responses so far.)

I'm not being unreasonable.

Starting from the 1930's, inflation has average roughly 3% annually.
http://inflationdata.com/inflation/I...eInflation.asp

Also note the performance of the US market, here benchmarked against US inflation. This graph runs from 1925 through 1995

http://www.duke.edu/~charvey/Classes...istory/5cu.gif

Here's another interesting link.

http://www.paritech.com/paritech-sit...on/Lesson2.asp

For more recent data, here's the average return of the Dow, from 1970 - 1999, which averages over 13%.

http://www.finfacts.com/stockperf.htm

Also, at the bottom of the page here, it shows the 70 year average of the DJIA from 1926-1996 to be right at 10%.

http://www.investorhome.com/history.htm

So, based on the historical data of even just the DJIA, a return of 10% annually less inflation of 3% gets you a return of roughly 7%, which if you plan on being more aggressive than the DJIA leads to a not unreasonable return of 8%.

IRA - contribute up to $3k annually, $3500 if you are over 50. Phase-out limits on deductible contributions if your AGI is over a certain limit.

401(k) - much, much more. $12k in 2003, or $14k if you are 50 or over.

IRA's look like government-sanctions tax shelters for retirement purposes.

As far as I understand, you don't pay taxes on any growth within the IRA, except for possibly when you "take the money out" of the IRA and want to spend it.

The government caps how much money you can put into all of your IRAs because of how sweet a deal it is: it is intended (if it is as simular to RRSPs as I think it is) to encourage you to save moderately for retirement.

CD's are FDIC insured deposit accounts. Basically you are correct here. You give the bank your money, and they keep it for a determinted amount of time. You may not withdraw any funds for that time period. However, if you must make a withdraw the bank may allow you to do so. You would lose your interest and probably pay some sort of a penalty fee.

I believe there are different types of Money Market accounts. The ones my bank does are deposit accounts that are also FDIC insured. I think of them as savings accounts with a higher monthly minimum balance, as well as higher interest. There is no risk involved, and the money is liquid. The account does fall under regulation D guidelines, which state you can only make 6 pre-authorized withdrawls per statement cycle.

Both account types are pretty low-risk investments. Don't know if you'd really wanna stick your money in an IRA this early. I guess it depends on your plans. There is better ways to invest your money as suggested above.