An Individual Retirement Account is a type of investment account, not an actual security. Technically, an IRA account cannot pay interest itself. However, you can invest in a number of different types of securities that do pay interest within the IRA account, and you can take distributions of this interest whenever you like. However, you may have to pay taxes or penalties to access your interest payments.
Interest is income that certain investments pay you in return for your money. Some of the types of investments that pay interest include savings accounts, money market accounts, certificates of deposit and bonds. While the interest rate on some investments such as savings accounts can fluctuate over time, some interest rates, like those on most bonds, are fixed. You can purchase all of these types of interest-generating investments within an IRA.
An IRA account carries certain tax advantages, such as the tax-deferred growth of income and the tax-deductibility of most contributions. Beyond that, an IRA functions must like a regular taxable investment account. The IRS publishes a list of prohibited transactions and investments that you cannot make in an IRA, but beyond these few limitations, you can purchase any type of investment in an IRA. If you invest in a security such as a bond that pays interest, the interest will remain in the account until you withdraw it.
In regular taxable investment accounts, you can have your interest payments sent directly to you with no tax consequences. As an IRA is a tax-advantaged account, if you withdraw interest payments, you must pay tax on them. The IRS considers all distributions from a traditional IRA to be ordinary income for tax purposes. If you are under age 59 1/2 when you withdraw funds from your IRA, the IRS considers this a premature distribution and will assess you a 10 percent penalty on top of the income tax owed on the withdrawal.
While you can invest in many interest-bearing investments in an IRA, the IRS does restrict some of your options. Specifically, you cannot invest in collectibles in your IRA, such as antiques, rugs, artwork, gems or metals. While these types of investments do not typically pay interest, investment real estate does. However, many firms that serve as IRA custodians do not allow investors to purchase real estate in an IRA, as there is additional paperwork involved. The IRS does allow real estate purchases in an IRA as long as the real estate is for investment purposes only, and not for use as a personal residence.
John Csiszar earned a Certified Financial Planner designation and served for 18 years as an investment counselor before becoming a writing and editing contractor for various private clients. In addition to writing thousands of articles for various online publications, he has published five educational books for young adults.