How does an IRA work? What determines how your yield is increased/decreased?

Question

I know the difference between traditional and roth. But I want to know how your money increases/decreases? Is it like a mutual fund? The bank just invests your money and hope to God that it increases? Is there a set standard yield that you are guaranteed to get?

Thanks in advance!

Answer 1

An IRA is an Individual Retirement Account. It's a tax-deferred retirement account for an individual that permits (think government) individuals to set aside money each year, with earnings tax-deferred until withdrawals begin at age 59 1/2 or later (or earlier, with a 10% penalty).

Within your IRA you can hold mutual funds, stocks, a money market fund, etc. Your money would increase/decrease just like it would if you held the investments outside of the IRA except that you don't pay taxes on gains and you can buy and sell without tax implications.

You make investment decisions, unless you let a broker do it for you.

Unless you hold something like a fixed annuity in your IRA (bad idea) there is no set yield.

Answer 2

You mentioned the "bank".  Are you using a bank to manage your IRA account for you? Or have you set up an IRA at a bank and deposited the money in a CD?  There are different ways in which an IRA account can be set up.

Some of these are the following:

Set up with a bank and depositied in CDs.  

Set up with a bank investment division and with their help invested in mutual funds, equities, or bonds, etc.

Set up with a mutual fund company and invested in their mutual funds.

Set up with a brokerage firm an invested as with a bank investment division.

If you invest in CDs, yes there is a standard yield.  Currently it is very little, less than the rate of inflation.

If you invest in mutual funds or equities then the yield will vary from year to year depending on how the equities perform or the mutual funds perform. Some years will yield excellent returns and other years the returns will be negative as they have tended to be so far this year.

Perhaps a few examples will help.

Let us suppose you have set up your IRA with Fidelity.

You can buy CDs for 2 years that pays 3.85%.  Inflation is running about 6% currently and will probably go to 8% before the 2 years is up.  Nevertheless, the 3.85% is guaranteed for 2 years.

You can buy one of the Fidelity mutual funds.  For example Fidelity Independence Fund which has had an annual return of about 9.4% for the past 10 years.  But that return has not been consistant.  From 2000 to 2003 it lost 1/2 its value.  That can be very distressing.

Answer 3

An IRA is not a specific investment - its just a type of retirement account.  Within the IRA, you can invest in whatever you want - bank CDs, mutual funds, etc.  There is no set "yield" - it depends on your particular investments.

Answer 4

An IRA is just a tax-deferred (or in case of Roth IRA, tax free) wrapper around whatever you want to invest in.  So what return you get depends upon where you open the account (broker, bank, insurance company), and what you invest in within the account.  If you just keep it in cash, CD, or money market, it may not keep up with inflation.

Maybe I am showing my age when I say that when I first started my IRA, it was a CD with a rate of 10% APR locked in for 5 years.  But that was long before the internet as we know it existed.  And I kept it there for many years until interest rates dropped below 5% and it was significantly lagging my 401(k).  A few years ago, I finally decided that I better start learning how to invest, so I know what to do with my 401(k) when the time comes to retire in about 10 years from now.

So I opened an IRA at Fidelity and started playing around with IRA money from an insurance company until the IRA CD expired and I had even a bigger pot of money to play with.  I also opened a Roth IRA and am converting some ot the IRA to that each year along with contributions.  I am not an expert yet, but am doing better than CD rates.

Answer 5

Not exactly. Sure, you can keep it in cash if you want, which will be safer, but less profitable. Or, if you have a self directed IRA you can buy and sell the stocks within your IRA tax free (which obviously increases your yield since you aren't paying taxes!) You can put it in mutual funds if you want...but I keep 80% of mine in equities and 20% in cash (in case I find a new stock I like)...I am assuming traditional or Roth can be self directed...but I don't know that for sure. Mine is traditional. I use it just like any other brokerage account. Only I don't pay taxes on it!