An individual retirement account or IRA is a personal account that an employee of a company can set up. The contributions to the account are tax deferrable until the funds are withdrawn after age 59 1/2. There are also several contribution limits which are set at $5000 per year.
An IRA is a great way for employees to invest a percentage of their paychecks every year so that they will have plenty when they decide to retire. Some IRA advantages are that the contributions are tax free or tax deferred. This means that the account holder will not have to pay taxes until they withdraw the funds after 59 1/2. However, if they take it out sooner than this age then there is a penalty fee. The great advantage of tax deferred contributions is that the account can earn more on interest over time than if the funds were first reduced by taxes and then put into an account. Another disadvantage is the contribution limit. This means that the individual can only earn so much over time even if the employee did want to contribute more.
Tim is working for Wawadoo Inc. and has decided that he would like to start an IRA account. He sets up the plan through the company and begins to contribute 10% of his paycheck to it. Tim makes $90,000 per year meaning that if allowed he would make contributions of $9,000 (90,000 * .1). However, he is only allowed to contribute $5,000 into his individual retirement account.