An IRA (Individual Retirement Account) is a way to save money for retirement while at the same time deferring taxes on the instrument's annual interest until you actually start using the money. The general thought behind this is that once you retire, your income will be less than while you were working. So once you start using money accumulated in an IRA, you will be taxed at a lower income bracket. When they first came into being, IRAs were all fixed-rate. More recently, however, IRAs have also been offered with a variable rate.
In addition to there being two basic types of IRAs (fixed rate and variable rate), there are three basic varieties: a Traditional IRA, a Roth IRA and a SEP IRA. All IRAs have the following in common. For any tax year, contributions must be made by April 15 of the following year. IRA contributions are limited to up to $5,000 a year, except if you are age 50 or older, in which case you can contribute up to $6,000 per year. If you wish, you can start to take distributions once you are 59.5 years old, but you do not have to start receiving payouts until you are 70.5. You can also deduct contributions to your IRA from your income taxes.
Variable Rate IRAs
Variable rate IRAs offer an opportunity to earn a higher return on your investment since their return is tied to an ever-changing economy. As with any variable rate instrument, there is no guaranteed amount of return. But since there is a higher risk involved, the potential return is higher, too. Your success will be determined completely by the state of the economy.
Is a Variable Rate IRA Right for You?
Your choice of IRA type depends upon two factors: how comfortable you are with risk and how diversified your portfolio is. If you are conservative when it comes to money, then a fixed rate might be better for you since you will be able to calculate exactly how much money you will have when you retire. On the other hand, if you are comfortable taking risks, then a variable rate IRA might be a better choice. Another consideration is your investment portfolio. If you have invested in other variable rate instruments, you might want to balance that out with a fixed-rate IRA. On the other hand, if your other investments are all fixed-rate, you can afford a bit more risk with a variable-rate IRA.
Drawbacks of IRAs
Generally speaking, IRAs are sound investments. A main drawback of all IRAs is that since they are intended for retirement, you will be charged a penalty (usually 10%) on early withdrawal of funds if you find you need the money earlier. Another drawback is that the government has capped how much you can contribute to an IRA each year.
One very nice thing about IRAs is that you can convert them to a different type once they have been set up. Each variety (Traditional, Roth and SEP) offers different advantages, depending upon the state of the economy. Just because you set up a Traditional IRA, for instance, does not mean it cannot be changed to a Roth IRA to take advantage of current financial conditions. See Resources for more detail on how this works.
Micah Rubenstein has been writing professionally since 1985. He was the editor of the online publication GrailWorld Magazine, the host and producer of the weekly "Message In Music" radio series and a former professor at Kenyon College in Gambier, Ohio. He teaches at Columbus State Community College and Granite State College in New Hampshire. He holds a Bachelor of Arts in music from Brown University.