What is an Individual Retirement Account?

Also known simply as an IRA, an Individual Retirement Account is a savings account in which the funds are not subject to tax at the time they are deposited in the fund. The IRA is a retirement funding option in the United States, but is not unique. Many other countries also have similar retirement plans that carry similar tax privileges, such as the Individual Savings Account, or ISA, that is offered in the United Kingdom.

The first Individual Retirement Account was offered in the United States in 1974. Legend has it that the designation of the savings plan as IRA was actually in recognition of one of the actuaries working on developing the offering, Ira Cohen. Other sources claim this was simply a coincidence, or nothing more than an urban legend.

Since the inception of the first Individual Retirement Account, a number of different types have emerged, each carrying a slightly different tax benefit. A traditional IRA has the benefit of incurring no taxes on the amount deposited annually, which can reduce the tax burden of the individual. Withdrawals from the account are counted as income during the years in which the withdrawal takes place. By contrast, a Roth IRA does allow the contributions to be taxed in the years they are made, but are tax-exempt when they are withdrawn in later years. Just about all forms of the Individual Retirement Account come with a penalty that must be paid in the event that withdrawals are made before the individual reaches the age of 59 ½.

As a retirement savings plan, the Individual Retirement Account allows workers to set aside a maximum amount of their income each year for deposit into the savings plan. Over the years, the total of that annual contribution has shifted upward, allowing for shifts in the economy and the standard of living. With the development of different types of IRAs, laws governing the total amount of annual contributions have been put in place that set a maximum amount that can be cumulatively placed in different accounts, assuming the worker has more than one IRA established.

For example, if the worker has a traditional IRA and also a Roth IRA, and the current regulations allow an individual to contribute up to $5,000 in US Dollars (USD) annually, the worker could choose to deposit equal amounts of $2,500.00 USD in each of the two accounts. However, the worker could not deposit $5,000 USD in each account.

Individuals over the age of 50 are allowed to contribute slightly larger amounts to an Individual Retirement Account each year. This can be especially important for workers who waited until later in life to begin contributing to an IRA, since it allows them to accumulate more reserves in the account than they would have managed otherwise. While it is possible to begin making withdrawals at the age of 59 ½ without incurring a penalty, many people choose to wait until reach full retirement age, which is 65 in the United States. Ideally, withdrawals from the IRA can be used to supplement pensions, 401(k) plans, and other retirement plans, thus limiting the amount of tax that is assessed each calendar year.