When looking forward to retirement, it is important to set yourself up for financial stability through investing now. Individual retirement accounts, or IRAs, offer an ideal way to invest money for retirement. Among the different types of IRAs is a variable-rate IRA that has the potential of being very lucrative. When you have the opportunity to invest, consider the benefits and disadvantages of a variable-rate IRA.
Read More: What is an IRA Basis?
Variable-Rate IRA Defined
An individual retirement account is a tool through which an individual can set aside funds for investing each year before retirement. Traditional IRAs are made up of pre-tax money that will be tax-deferred until retirement age. Roth IRAs are made up of post-tax money and will not be subject to tax in retirement years.
A variable-rate IRA is a form of either a Roth IRA or a traditional IRA. This means you can add either pre-tax or post-tax money to the account. Once you establish what type you want, you must stick to those types of contributions moving forward. Once you've determined the type, you'll decide on a term. Some choose 18 months, others choose several years for the term. Then you'll shop for interest rates.
The defining option in a variable-rate IRA is the interest rate. There are fixed-rate IRAs that have a consistent interest rate throughout the lifetime of the investment. The variable-rate IRA is so-called because the interest rate is continuously changing for the duration of the investment term. Sometimes you'll hear them referenced as floating interest rates.
Variable-Rate IRA Benefits
There are a couple of benefits to choosing a variable-rate IRA. Perhaps the most attractive benefit is the ability to start a variable-rate IRA with a smaller amount of money than you'd need for a fixed-rate IRA. Typically, a fixed-rate IRA requires an initial deposit sum over $500 but usually requires more. A variable-rate IRA can be opened with as little as $5 to $100.
An additional advantage is that the interest that accrues can be taken out during the grace period specified on the account. While other forms of IRAs levy a penalty for any withdrawals before the term is up, you won't have to worry about that with a variable-rate IRA, so long as it is the interest only being withdrawn.
Disadvantages of a Variable-Rate IRA
Perhaps the biggest drawback to a variable-rate IRA is the unknown interest rate. With a fixed-rate IRA, you know how much growth to expect on your money. With a variable rate, you could have rates change monthly or yearly and not really be able to gauge the amount you'll make on the money you deposit.
Also, the bank or credit union that holds the account is not bound by law to notify you when they change the rates. The rates can change daily and the interest you gain can dwindle at times. It is hard to know if you'll make good interest over the life of the loan.
Account Maturity Options
When you have reached the maturity date on the variable-rate IRA, it is important to take the necessary steps to avoid penalties. If you withdraw the money from the account before you are 59.5 years of age, you'll be charged a 10 percent penalty. In addition, the money will be added to your income for the year, and you'll be taxed according to your tax bracket. It's important to know your options.
If you do nothing with the account at the end of the term, the bank or financial institution holding the account could automatically renew the account under the same terms and conditions.
If you want to roll over the IRA, you'll need to find a bank that can take the account and roll it into another variable-rate IRA. This might be smart if the interest rates were not very good at the previous institution.
Understand that most IRAs have a 30-day grace period to roll over or withdraw the money. Within 30 days of the maturity date, you will need to have moved the funds in some way out of the account or continue with the same conditions with the same institution. This will help you avoid all penalties and allow you to continue to build a hefty savings for retirement years.
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With over seven years of freelance writing experience across a variety of genres, I have quite a bit of education and research to share with those looking for financial guidance. My personal experiences, including two house purchases, two paid off car loans, home refinance, and a Home Equity Line of Credit process, give me the practical knowledge to assist with large financial decisions. Meanwhile, budgeting everyday necessities for a family of seven focuses my expertise on daily savings. In addition, I have written financial articles for a top ranking finance site, Go Banking Rates.