What are IRAs?
Individual Retirement Accounts, or IRAs, is a personal saving account for individuals to save for their retirement. One of the main reasons for opening an IRA is the income tax advantage provided to the individual while they are saving.
When money is deposited into an IRA, it is often called a contribution. During the same year that the contributions are made, an income tax deduction will be available. This deduction will vary based on the amount of the deductions and also the tax laws. Most laws state an upper limit of how much can be invested in the IRA. This limit is usually tied to the amount of income received by the individual that year.
As long as no withdrawals are made from the account, the money invested, plus any earnings made on it, will accrue tax free. Each year, income and gains will be generated on the contributions plus increases from previous years without having to pay any taxes. Each year, further contributions can be made to the IRA up to the allowable limit for that time frame. It is important to remember that IRAs are designed to save for retirement, so most have early withdrawal fees, often as high as 10%, particularly if the individual begins to draw before the age of 59 ½.
There are a number of different types of IRAs available, including a traditional IRA, education IRA, simplified employee pension (SEP) IRA, simple IRA and Roth IRA. SEP and simple IRAs are IRAs created by employers for employees. Traditional, education and Roth IRAs are accounts opened by individuals for their own benefit. As the name implies, education IRAs are used to save for paying for further education. This type of IRA can be withdrawn prior to age 59 ½ if it is used to fund education costs.
What are Fixed Rate IRAs?
As with most investment or borrowing accounts, individuals can choose between fixed or variable interest rates. The same is true of IRAs. Many financial institutions offer both fixed rate and variable rate traditional, and Roth IRAs, while some also offer the choice for education IRAs also. The circumstances of the individual and their savings plan will determine whether fixed rate or variable rate is the right plan for them.
The main differences between fixed and variable rate IRAs are how the deposits are made and interest paid. With a fixed rate IRA, the individual agrees to deposit a certain amount of money over a specific period of time. There is usually an opening deposit amount and deposits are set up at regular intervals. Because the individual has agreed to “lend” this amount of money to the financial institution for the stated period, the benefit is often higher returns and a fixed interest rate for the entire period.
Variable rate IRAs work much the same as other variable rate investments, like mutual funds. Contributions can be made whenever the individual likes and the money is not locked in for a certain period of time. As such, the interest rate is not locked either, so it will fluctuate with market conditions. For short term investing, variable rate IRAs may make more sense, but only if the market shares gain in value.
Benefits of Fixed Rate IRAs
As stated, individuals who decide to invest in fixed rate IRAs can benefit from higher returns due to higher interest rates. The longer the money is invested and the greater the amount, the higher the interest rate. Because the investment is in an IRA, the interest generated on the contributions remains untaxed until they begin withdrawals.
Fixed rate IRAs provide more security compared to variable rate IRAs. A guaranteed interest rate over the term of the contribution is provided for fixed rate IRAs. If the market is particularly volatile, a fixed rate IRA will remain stable, allowing for a better forecast of the final amount saved.
In the end, deciding between a fixed rate IRA and a variable rate IRA comes down to the amount of risk the individual is willing to take with their portfolio. For higher, short-term gains, a variable rate IRA may be more popular. For many, the guarantee of a set amount of future income is what makes fixed rate IRAs more attractive to many investors. For those who are looking at long term investments, fixed rate IRAs, where the contributions role over, are likely to be the better bet.