Individual retirement accounts are an umbrella account in which you can invest your money in a variety of ways, including putting your IRA money into a savings account. Although IRAs are designed to offer advantages over regular savings accounts if you're saving for retirement, you could run into trouble if you want your money early.
The biggest benefit to using an IRA is the tax advantage. Whether you use a traditional IRA or a Roth IRA, the money grows tax-free in the account. Traditional IRAs offer the benefit of tax-deductible contributions, but tax distributions. Roth IRAs don't give a deduction for contributions, but your qualified distributions come out tax-free. Whichever option you choose, you're getting a tax break that you wouldn't with a savings account.
The downside to using an IRA is the potential for early withdrawal penalties. For traditional IRAs, any distribution before age 59 1/2 is a non-qualified distribution, which is subject to the extra 10 percent tax penalty for early withdrawals. However, the downside isn't as bad for Roth IRAs because you can withdraw your contributions at any time tax-free and penalty-free. After you've withdrawn your contributions, your earnings are then taxed and penalized. Your account must be at least five years old to take a qualified distribution from a Roth IRA and you must be age 59 1/2, permanently disabled or using up to $10,000 for a first house purchase.
Savings Account Benefits
Savings accounts allow you to access your money when you need it without having to worry about any early withdrawal penalties. For example, if you get in a car accident and need to buy a new car, you can use your savings account without any negative tax benefits, which you might not be able to do with an IRA. In addition, there isn't a contribution limit on savings accounts. As of 2018, IRAs restrict annual contributions to $5,500 ($6,500 if you're 50 or older).
Savings Account Drawbacks
Savings accounts don't offer any tax breaks such as deductions for contributions or tax-sheltered growth. For example, each year, you must include any interest earned on the account in your taxable income for the year, which lowers the after-tax rate of return. Unlike the IRA, savings accounts typically offer a much lower rate of return, which is considered a fair "trade" for the security and lack of volatility they provide.
Weighing Your Options
Given the fact that savings accounts and IRAs each provide unique 'selling points', it is not uncommon for individuals to allocate funds to each platform in hopes of striking a successful balance between yield and risk. Depending upon your age and your specific financial goals, you may find that your appetite for risk is larger than for those who are on the verge of retirement. In this case, an IRA may seem to be a more compatible option. Likewise, if you are ready to end your working career, storing funds in a savings account will all but ensure that this money is available as needed.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."