What is an Investment Retirement Account?
Is an Investment Retirement Account a new retirement plan? If you are
new to Retirement Planning and, more specifically, Retirement Investment
Planning some concepts might be confusing. Let me try to clarify.
An Investment Retirement Account is a generic term for government and employer sponsored retirement plans.
In the United States of America these plans include 401k retirement plans, 403b retirement plans, and 457 retirement plans - discussed elsewhere on this Web site.
To add to the confusion the term Investment Retirement Account is often, in the same context, called an Individual Investment Account or an Individual Investment Arrangement or IRA.
These however, are specific retirement plans in the United States of America.
Let's use IRA as the generic term for this discussion.
The four pillars of an IRA are:
- Regular saving
- Compound interest
- Tax free income
- Tax deferred growth
Regular saving
People – you and I – simply do not, or did not, put a priority on regular saving when young. An IRA demands regular saving however small it is.
Compound Interest
The power of compound interest is exponential. You receive interest every month on your total savings as well as on your total previously earned interest! The longer the compounding period the more spectacular the results.
Tax free income
You don't pay tax – up to a limit set by government – on the amount you regularly save. Often your employer will match your savings amount with an equal contribution which is effectively free money, tax free. This really accelerates the compounding interest effect.
Tax deferred growth
Typically your money is allowed to grow tax free in an IRA. You only pay tax when you withdraw funds from your account.
Which plan to choose?
The debate around a tax advantaged IRA plan – the pros and cons of one plan against the other – seem to me to be irrelevant!
Let me say immediately that these plans would work wonderfully for a young person who starts early in his or her working life to make regular contributions to an IRA.
But in my experience very few youngsters take retirement provision seriously in their early working days. It is only when you get within 15 years of retirement that you get really serious. That happened to me too.
At that time the tax advantaged investment plans are not going to add up enough in your retirement account. You need to start saving substantially more than governments allow as a tax advantage.
You need to save more of your taxed income.
You need to curb excessive consumption.
You need to explore the possibilities of multiple income streams.
It is at this stage that you are prone to schemes that are too good to be true. Don't invest in such schemes. Stay with a diversified and conservative spread of your IRA.
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