What is an
SMALL
An IRA is a tax-advantaged investment account that you can use to save for retirement. Technically, IRA stands for Individual Retirement Arrangement, but the ‘A’ in the acronym is colloquially referred to as an account.
How IRAs work
At the most basic level, there are two kinds of stock: preferred and common. Preferred stock is rarer than common stock, generally comprising a small proportion of all shares. It’s often more expensive, and can come with a minimum purchase amount.
Types of IRAs
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How IRAs work, types of IRAs and more
SHORT-TERM
CAPITAL GAINS
Profits made from selling assets owned for one year or less.
LONG-TERM
CAPITAL GAINS
Profits made from selling assets owned for more than one year.
Jeff bought a vacation home for $100,000 and used it as a rental property for five years before selling it for $150,000, giving him a capital gain of $50,000.
Since he owned the property for more than one year, he calculated his long-term capital gain based on his tax bracket.
Since his annual income placed him in the 15 percent tax bracket ($37,651 to $91,150 for a single person in 2016), he didn’t have to pay any taxes on the profit.
If Susan pays only the minimum payment of $20 per month, it will take her 11 months to pay off her balance.
EBITDA doesn’t need to be measured by the Securities and Exchange Commission’s accounting standards, the Generally Accepted Accounting Principles (GAAP), so it is not a required line item on a company’s financial statement. EBITDA has become much more common in recent years, although many firms list an adjusted EBITDA figure.
Before the proliferation of
inexpensive computer
technology, it had been very
difficult to create and price
complicated derivative contracts, but this problem was more or less solved by the 1990s, thanks also to the Black-Scholes equation. Mortgage-backed securities became very common investment products. Instead of using derivatives to effectively balance risk, institutional traders began buying them up as ways to create leverage and take on much more risk. When the U.S. housing market began to crumble in 2006 and 2007, MBS investments spread throughout the banking system began to rapidly lose value, precipitating the crisis.
MARKET CAP
VALUE
OUTSTANDING SHARES
SHARE PRICE
OF THE STOCK
When a company issues more shares, the price of an individual share falls. Anti-dilutive preferred stock allows investors to receive more shares of a stock than he original paid for in the event that his are worth less as a result of a dilution.
The measure can be calculated by taking a company’s net income and adding back interest expense, taxes, depreciation, and amortization. Alternatively, it can be calculated by taking a company’s operating profit — EBIT, or earnings before interest and taxes — and adding depreciation and amortization.
Susan opens a credit card with a $1,000 credit limit and an interest rate of 14.99.
She makes a purchase of $200.
Susan understands she will pay interest on the balance until she pays it off, but she decides to carry a revolving balance.
If Susan pays only the minimum payment of $20 per month, it will take her 11 months to pay off her balance.
If shares of Dynaco rise
above $150, the buyer of
the options wins and
Englebert is obligated to
sell 100 shares to the
holder for $150. But if they
never hit the strike price of $150, Englebert wins and gets to keep the $200 premium the buyer paid. If shares of Dynaco get closer to the strike price of $150, the buyer can resell the option and make a profit off his speculative bet, but if shares of Dynaco decline — widening the spread between the strike price and the underlying asset price — the price of the option falls.
$100 million
$2
$20 million
$10 million
– Minus
PRICE PER SHARE
EXPENSES
Equals =
$30 million
NET PROFIT
>$10B
Using an IRA versus a regular taxable brokerage account for retirement feels similar to the difference between speeding through the E-Z Pass lane on the highway or stopping at the toll booth every 20 miles: You’re going to get where you want to go a bit faster without having to stop at the tax tollbooth every year as you would with a regular brokerage account.
x
=
$10 Billion
PRICE/SHARE
MARKET CAP VALUE
NOT A LARGE CAP COMPANY
OUTSTANDING SHARES
PRICE/SHARE
MARKET CAP VALUE
A LARGE CAP COMPANY
=
63,000,000
$200
$12.6 Billion
Convertible preferred stock can be exchanged for common stock, but not vice versa.
Convertibility:
Anti-dilution:
If you don’t feel well equipped to direct (in other words, choose investments for) your IRA, it’s wise to browse robo-advisors or pick a target-date retirement fund. Both are low-cost ways to get broad-based diversification tailored to your time horizon and your risk tolerance.
The shareholder has the right to redeem her shares for a predetermined amount called a call price.
Callability:
EARLY WITHDRAWAL
IRA?
$300M–$2B
MARKET CAP
VALUE
OUTSTANDING SHARES
SHARE PRICE
OF THE STOCK
Amortization also refers to the practice of spreading out business expenses over the course of years, as opposed to paying them off all at once. This allows the business to soften the blow of expenses by showing one large expense as a series of smaller ones over a period of time.
OUTSTANDING SHARES
PRICE/SHARE
MARKET CAP VALUE
A SMALL CAP COMPANY
=
30,000,000
$41
$1.23 Billion
When you open an IRA, you contribute funds that can then be invested in a wide range of assets — CDs, stocks, bonds and other investments. You’re not limited to a menu of investments as you often are in a 401(k). That means you can take full control of picking how this account is invested.
The yearly profits from TIPS are considered taxable income by the IRS, even if the TIPS aren’t redeemed. Given the tax implications of TIPS investments, many investors purchase TIPS through mutual funds or deferred retirement accounts.
The S&P 500 index is part of the S&P Global 1200 family of indexes. Other members of the S&P Global 1200 family of indexes include the S&P MidCap 400, which measures the performance of stocks based on 400 midsize companies, and the S&P SmallCap 600, which measures stock performance based on 600 small companies.
IRAs come in two flavors: traditional and Roth. There are two fundamental differences between them: whether you pay taxes before contributing or after withdrawing funds, and when you are required to withdraw funds.
5/5 ARM
A 5/5 ARM features a fixed period for five years, with a change allowed every five years after that initial period.
2/28 ARM
In this form, a fixed rate remains in place for two years. Then, a floating rate (a rate that can adjust from time to time) occurs over the next 28 years.
RETIREMENT SAVINGS TERMS
IRA
What is an individual retirement account (IRA)?
IRAs are particularly valuable tools for the 33 percent of private industry workers in the U.S. who do not have access to a workplace-based retirement plan. Too often, that lack of a 401(k) from an employer means that people don’t save for retirement, but IRAs give all workers a convenient way to prepare for their golden years.
It’s important to note that IRAs can also be ideal for the 67 percent of people who do have access to a workplace-based plan. If you’re maxing out your contributions there or you simply want another option with more control over your investment, an IRA can present a great way to save even more money for retirement.
No matter when you’re hoping to retire, today’s asset allocation — how you split your money between stocks, bonds and other investments — is absolutely critical to tomorrow’s earnings. In fact, some studies have shown that asset allocation determines as much as 90 percent of an investor’s total return. IRAs offer flexibility in adjusting those investments, too. You can move in and out of them — for example, shifting your money from individual stocks to bonds — without incurring capital gains taxes.
While you can move the money around freely, you can’t take it out early. An IRA is designed for retirement, which means that withdrawals before you are 59 1/2 will incur both taxes and a hefty penalty of 10
percent — unless you’re using the money for special exceptions such as buying your first home or paying for higher education (and those exceptions come with caveats).
Traditional IRA
With a traditional IRA, you could be eligible to receive a tax deduction in the year you make the contribution (up to a cap on the contribution of $6,000, or $7,000 if you’re 50 or older). When you withdraw the funds later, you’ll pay taxes on the full amount you are withdrawing. Once you turn 72, you must start making withdrawals.
A Roth IRA doesn’t offer the instant gratification of an immediate tax break. Instead, you’ll pay taxes on your income now, contribute it to a Roth IRA and avoid taxes when you withdraw the proceeds when you retire. However, there is no requirement to make withdrawals from a Roth IRA.
Roth IRA
When comparing traditional and Roth IRAs, it’s fairly common to think about current tax status versus your tax status in retirement with the assumption that you’ll be in a lower tax bracket when you are no longer working.
However, I recommend avoiding that debate. Why? Because it’s very difficult to predict your tax bracket 30 years from today. Instead, look at this from the perspective of diversifying your tax exposure and giving that money even more time to grow and compound without the headwind of taxes. Regardless of your future tax bracket, having some assets accumulated in a Roth IRA that can later be withdrawn tax-free is worth considering.
How to open an IRA
To open an IRA, you or your spouse need to have earned income from working. You can open an IRA at a wide range of places including brokerage firms, mutual fund companies, banks and credit unions. Pay attention to management fees, commissions and minimum opening requirements to make sure you find a good deal.
And in addition to the basic terms of each IRA, compare educational resources if you plan on being in the driver’s seat making your own investing decisions. Some firms offer robust tools to help you understand the market and make wise choices.
IRA contribution limits
The government places limits on the amount you can contribute to all your IRA accounts, which change every few years based on inflation. If you’re under 50, your contributions are capped at $6,000 in 2021. If you’re over 50, your limit increases to $7,000.
If you’re under 50, your contributions are capped at $6,000 in 2021.
If you’re over 50, your limit increases to $7,000.
Before you think about how
to maximize your IRA contributions, though, you need to make sure that your annual earnings fall within the government’s threshold. Your deduction capability begins to phase out as your income increases. The limits vary based on your filing status, so check the IRS’ updated guidelines to verify your eligibility.
The most affordable options for IRAs will be found at no-load mutual fund firms, online brokerages and robo-advisors. Before comparing and deciding where to open an IRA, you should consider which kind of IRA is the best fit for your needs. Keep in mind, too, that the decision between a traditional and Roth IRA is not an all-or-nothing choice. You can have both — you’ll just want to make sure your annual contributions don’t exceed the limits.
Comparing IRA options
Type of IRA
Traditional
Roth
$6,000 if under 50; $7,000 if over 50
Annual contribution limit
$6,000 if under 50; $7,000 if over 50
Can you deduct the contribution on your taxes?
(subject to income limitations)
Can you withdraw the money tax-free?
When do you have to start withdrawals?
Age 72
Never