What is an Individual Retirement Account (IRA)? - SBNRI (2024)

An Individual retirement account (IRA) is a form of an individual retirement plan that helps customers save for retirement with tax advantages. Four popular types of IRAs include traditional IRA, Roth IRA, SEP and SIMPLE IRAs, provided by many financial institutions such as banks, Robo-advisors and brokers. Your contributions to the IRA may be tax-deductible, or withdrawals may be tax-free.

Also Read: What to do with your 401(k) if you move back to India

Indians legally working and living in the USA can also open an IRA. Non-citizens including people from India can have a 401(k) and a traditional or Roth IRA, too.

How do IRAs (Individual Retirement Acounts) work?

Investing in an IRA allows you to grow and compound your money. You can invest in stocks, bonds and other assets. How your investment grows depends on your contribution and how you invest in the IRA. You can contribute to an IRA based on your financial situation and risk tolerance. Since this is a retirement account, you are not allowed to withdraw funds before you turn 60 years. If you withdraw funds before your retirement age, you may have to pay a penalty for the same.

Benefits of Investing in an IRA

IRA gives you the ability to have more investment options and choices than 401(k). If you make maximum investment in an IRA, it can help you prepare for retirement, save on taxes and access investment options that the retirement plan offered by your employer might not offer.

Employees who have an old 401(k) can also move the funds into a rollover IRA. The benefit of a rollover IRA is that the fund keeps its tax-deferred status and doesn’t attract taxes or early withdrawal penalties.

Types of Individual Retirement Accounts

There are three popular types of IRAs. Each of them has its own tax implications and eligibility requirements.

A traditional IRA

Contributions to traditional IRAs are tax-deductible in most cases. For example, if you contribute $5,000 to an IRA, your taxable income for the year gets reduced by $5,000. However, withdrawals from traditional IRAs at the time of retirement are taxable at your ordinary income tax rate. Individual contributions to traditional IRA can’t be more than $6,000 in most cases.

Roth IRA

Contributions to a Roth IRA are not tax-deductible, but investment gains are tax-free at the time of retirement. Unlike the traditional IRA, you can’t claim deductions from your taxable income at the time of contribution to Roth IRA. However, at the time of your retirement, you can withdraw from the account without incurring any income taxes on your withdrawals. The individual contribution limits to Roth IRA for 2020 and 2021 tax years are the same as for traditional years.

Simple IRA

Small business owners and self-employed individuals with 100 or fewer employees can use a SIMPLE (Savings Incentive Match Plan for Employees) IRA (Individual Retirement Account). SIMPLE IRAs are easy to set up and their maintenance costs are low. employers get a tax deduction for contributions they make for employees.

Which is better to have a 401(k) or individual retirement account?

The major difference between an IRA and a 401(k) is that a 401(k) is offered by your employer, while you have to open an IRA yourself through a broker or bank. IRAs usually offer more investment options and 401(k) allows higher annual contributions.

You can also have both. It is wise to have a 401(k) if you get the full employer match on it. You can open an IRA to boost your retirement savings. If you don’t get an employer match, if the 401(k) you get has fewer investment options and you want to max out your 401(k), investment in an IRA might be a good idea.

Also Read: Withdrawing 401k from India and the associated tax implications

As an NRI in the USA, you may have several questions regarding the IRA, 401(k) rollover to IRA, 401k withdrawal from India, tax implications on it, and so on and so forth.

SBNRI understands the struggles NRIs go through considering the rollover or withdrawals from their 401k retirement account in India. You can download SBNRI App from the Google Play Store or App Store to ask any questions related to 401 rollover options, NRI investment in stock market/ mutual funds, NRI account opening online and tax filing in India. Also, visit our blog and YouTube channel for more details.

Ask Indian Friend Now