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I'm trying to understand the benefits of IRAs. I get that an IRA is an account for retirement in which I keep investments. And I get the difference between Roth and Traditional IRAs (in fact, that's the only comparison I can find when searching my topic), but what about an IRA vs. other investments which aren't in an IRA?

I suppose there are possible tax benefits... but there's also possible penalties and fees.

So why would I open an IRA instead of simply investing in the funds that would otherwise go into the IRA? (And I'm looking at long-term investments here.)

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IRA is a tax-deferred account. I.e.: you're not paying any taxes on the income within the account (as long as you don't withdraw it) and you can deduct the investment (with certain limitation on how much, depending on your total AGI). It is taxed when you withdraw it - at ordinary rates for the "traditional" IRA and with 0% rate for ROTH, as long as the withdrawal is qualified (if not qualified - you pay ordinary rate tax for ROTH and additional 10% tax for both on the taxable amounts).

The details are a bit complicated (there's deductible IRA, non-deductible IRA, roll-overs, etc etc), but that's the basic.

Regular investment accounts are taxed currently on any income, but you get the "better" capital gains rates on many things. So which one is better depends how long your investment is going to be, what is your tax situation now, and what you anticipate it to be later when you retire.

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  • If I understand correctly, basically: investment accounts are taxed at any of two times: along the way/as you deposit, or at a withdrawal of funds. Regular investments are taxed both ways, but IRAs are only taxed with one of those ways. Is that close?
    – Matt
    Apr 4, 2013 at 0:21
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    @Matt no, regular investment accounts are taxed when there's gain. For example, you bought stock X for $100, sold it a month later for $200 - you have to pay tax on $100 gain immediately. If it is in IRA - you get the whole $100 and you pay the tax when you withdraw the money 40 years from now.
    – littleadv
    Apr 4, 2013 at 0:25
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Part of the magic of the Traditional Pretax IRA is that money that goes in saves you your marginal rate, say 25%. It will grow tax deferred for the decades till retirement, and when withdrawn, you have the Standard Deduction, Exemptions, and lower brackets to fill. So it's withdrawn at your average retirement rate, which for a single this year, $4991 is the tax on $46250, just under 11%. (the $46250 adds the top of the 15% bracket ($36,250) the STD deduction ($6100) and Exemption ($3900)).

I recommend Roth if at 15% or lower, and move to pretax for 25% money. This is the simplest approach to describe.

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