Individual retirement arrangements, commonly known as IRAs, allow individuals to save for retirement while enjoying tax benefits on their invested funds. With some IRAs, contributions may be made only by sources other than the account holder. An employer-sponsored IRA and a rollover IRA are examples. An IRA is considered "contributory," however, if it is funded by contributions made directly to the account by and at the discretion of the account holder.
Account holders typically open and maintain IRAs through financial institutions. As the account holder makes contributions, the account manager places the funds in investment vehicles like mutual funds, bonds, stocks or even real estate that are directed by the account holder. Returns on these investments flow back into the IRA on a tax-deferred basis -- on a traditional IRA, no tax is due on the growth of the money or generally on the contributions until it is withdrawn in retirement, and on a Roth IRA, contributions and growth can be withdrawn tax free after age 59 1/2.
Contributory IRAs generally fall into two types: traditional and Roth. In a traditional contributory IRA configuration, the Internal Revenue Service allows account holders, with a few exceptions, to contribute to the account using pre-tax dollars. This arrangement allows account holders to invest and grow funds that would have otherwise gone to pay taxes. Income taxes are paid only when the funds are withdrawn from the account. In a Roth arrangement, the account holder makes contributions after paying taxes on the invested money. but the money is allowed to grow tax free, and it can be withdrawn tax free after age 59 1/2.
Contributory IRA account holders may direct investment activities themselves or allow a professional money manager to handle their investments at their discretion.
Employer sponsored IRAs such as SIMPLE IRAs and SEP IRAs do not allow account holders to make direct contributions. For a SEP IRA, for example, the employer contributes to the account on behalf of the employee. SIMPLE IRAs are funded through money that employers deduct from wages.
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