Legal Definitions - individual retirement account

An individual retirement account (IRA) is a type of savings or brokerage account that allows a person to contribute a certain amount of earned income each year. The contributions, along with any interest earned, are not taxed until the money is withdrawn after the account holder reaches 59 1/2 years old. If money is withdrawn before then, a 10% penalty may apply.

There are different types of IRAs, including:

• Traditional IRA: Contributions are tax-deductible, but taxes are paid when money is withdrawn.
• Roth IRA: Contributions are not tax-deductible, but money can be withdrawn tax-free if certain rules are followed.
• Education IRA: A type of IRA that allows tax-free withdrawals for education expenses.

Let's say John has a traditional IRA and contributes $5,000 per year. He earns interest on his contributions, but does not pay taxes on that interest until he withdraws the money. When John turns 65 and starts withdrawing money from his IRA, he will pay taxes on the amount he withdraws.

Another example is Sarah, who has a Roth IRA. She contributes $3,000 per year and earns interest on her contributions. When Sarah turns 60 and starts withdrawing money from her Roth IRA, she will not have to pay taxes on the amount she withdraws, as long as she follows the rules for Roth IRA withdrawals.

These examples illustrate how IRAs work and the different tax implications for different types of IRAs.