Is an IRA a Mutual Fund?
An Individual Retirement Account, or IRA, is a tax-advantaged retirement savings vehicle funded with after-tax income. A mutual fund is a pooled investment vehicle holding various securities that may be actively or passively managed.
Before selecting an IRA, ensure it fits both your short- and long-term investment goals as well as risk tolerance, taking tax considerations into account.
Definition
An Individual Retirement Account, or IRA, offers tax-advantaged investment options that could save you thousands in taxes over your career. Congress sets contribution limits and custodians can purchase most types of publicly traded securities through an IRA custodian; however certain assets such as collectibles, real estate or life insurance cannot be held within it.
Individuals have various IRA options available to them, including traditional IRAs, Roth IRAs and SIMPLE IRAs. While their rules vary slightly for each type, all three allow investors to contribute pre-tax or post-tax dollars while withdrawing earnings tax free upon retirement.
Conversely, brokerage accounts require you to pay taxes on profitable trades when they take place and also require you to decide how you’d like your money invested – such as whether hands-on management is desired or you prefer an automated service like Robo-advisors to manage it for you. In contrast, IRAs usually feature lower expense ratios due to investors choosing funds (or fund share classes) without commission fees paid out over time for financial professionals’ advice and expertise.
Taxes
Individual retirement accounts (IRAs) provide tax-advantaged savings opportunities outside of employer-sponsored plans like 401(k). They often provide more investment options than company plans and can have various tax consequences depending on which type of IRA an investor chooses.
With a traditional IRA, for instance, no taxes are levied until withdrawals are taken upon retirement. Any withdrawals prior to this point will incur income tax as well as an additional 10% federal tax fee (unless an exception applies).
Roth IRAs allow contributions to be made with after-tax dollars and earnings are tax-free upon withdrawal in retirement. SEP IRAs and SIMPLE IRAs, on the other hand, allow employers (typically small businesses or self-employed individuals) to make retirement plan contributions on behalf of employees; each has its own rules but all offer investors tax advantages.
Investments
Individual retirement accounts offer an array of investment choices. You can purchase securities like stocks, bonds, mutual funds and exchange-traded funds (ETFs). Furthermore, certain types of IRAs offer real estate investments or promissory notes as potential investments.
Mutual funds offer broad diversification with low costs for IRA investors, but your fund selection should depend on what role it will play in your overall portfolio – for instance, income funds provide regular, steady income while capital appreciation funds tend to produce longer-term gains.
Self-directed IRAs may also provide you with the option of investing in assets not available through traditional and Roth IRAs, such as rental property and precious metals. Promissory notes and private placements may be purchased using self-directed IRAs; however these strategies tend to be more complicated for novice investors. IRA certificates of deposit (CDs) provide guaranteed rates of return that are FDIC insured.
Withdrawals
Withdrawals from an Individual Retirement Account are taxed like any other investment income. An IRA allows you to hold any type of securities – individual stocks and bonds, mutual funds, exchange-traded funds (ETFs), as well as cash.
No matter which IRA type you select – savings, Roth, or traditional – early withdrawal incurs a stiff penalty in addition to ordinary income taxes owed. There are exceptions, however; such as qualifying first-time home purchase transactions, disability, or death.
When selecting a fund, keep active management in mind, which involves human portfolio managers making investments they believe will outperform the market. Passive investing utilizes algorithms that monitor market sectors or indexes without direct human management involvement. Each investment carries its own risks and costs that should be carefully considered before investing – for more details please read the prospectus or summary prospectus of each fund.
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