Help me with my IRA understanding

An IRA is like and umbrella and your investments fall under the umbrella to protect you from taxes. Some IrAs take taxes money in and produce tax free money on the withdraw other types take free money on the front end and produce taxed money on the withdrawal

I remember being confused about this also back when teachers recommended this to us. Think of it like a special label that you apply normal financial things.You can have an IRA savings account, that increases a very small percentage in value each year like a regular savings account. You can have an IRA Certificate of Deposit, that increases a slightly bigger but still tiny amount. You can open an IRA investment account to hold shares of stocks, bonds or mutual funds that can increase or decrease dramatically in value over time. You can only give the IRA label to a certain amount of your money each year, and there are special rules that make you pay a big penalty if you take that money out of the IRA before you're 59.5 years old.

Your teacher was probably basing this amount on something he or she read somewhere, which would've assumed that your IRA money would increase by an average value over time. For example, the stocks/bonds/mutual funds you hold might increase in value dramatically one year and decrease dramatically the next, but if the increases and decreases average out to x% over time then you'd have a million dollars by age y.

An IRA is simply a kind of brokerage account with special rules regarding contributions and withdrawals. Once you put money into an IRA you can then invest stocks, bonds, funds, etc. just like you can a regular brokerage account. Just about everyone is better off investing in something like a target retirement fund and not trying to pick stocks.

The idea is to contribute as much as possible up to the legal limit for the year (currently $5500) and do this year in and year out. Eventually you'll look at the account and realize you have a pretty good pile. If you do it for an entire working career it can be a really good pile.

There are two major kinds of IRA - the traditional and the Roth. The main difference between the two is that if you contribute to the traditional, then you get to deduct that amount from your income tax bill. When you start taking money out in retirement, it's treated as ordinary income and is taxable. If you try to take any of it out *before* retirement there are stiff penalties, so this isn't advisable.

With the Roth you contribute after paying taxes so it isn't deductible. OTOH, you can pull it back out anytime you like without any penalty at all, and anything you earn is tax-free too when you are retired. This means that you don't need to worry about putting money in an emergency fund unless you've already maxed your Roth contribution for the year.

tl/dr; IRA's are accounts that give you better tax treatment than an ordinary brokerage account.

Protip - 401(k)'s also come in traditional and Roth varieties and have much higher contribution limits, but they are employer-sponsored whereas the IRA is entirely within your control. They are good too though.

quote:

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Billboards all over town with the banks advertising 2000$ year in an IRA and retire a millionaire. Rates came back to reality and shattered that dream.

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The problem is that if inflation had remained as high as it was then, $1 million in 30 years wouldn't have been worth much.

Foshizzle you're exactly right. Even in this low inflation era I have this argument with people all the time. If you apply the 4-5% draw a year rule to a million dollars that's 40-50K a year. You're not exactly filthy rich and living high if you retire early on that.