I should do a post of the most commonly asked questions I get when talking about personal finance with folks.
How much interest is your IRA paying would probably rank in the top five for sure!
Or you could phrase it this way – what are your IRA rates these days? Or even, What’s the best IRA you’ve got?!
My guess is that this question originates from folks investing into bank IRA CDs.
Obviously with CDs, the interest rates bear whatever the going rates are in the market. After so much time investing IRA money into bank CDs, it’s natural to ask what are your IRA rates.
This is a common misconception, and one that I’ll dispel for you today.
IRA’s Don’t Pay Rates, CDs and Savings Accounts Do
If banks are using lingo with their customers like, “Our IRA rates are the best in town!”, they need to stop!
It’s creating confusion. IRA rates are a misnomer. IRA’s don’t pay rates, CD’s and savings account do!
I did a quick search for “IRA Rates” and there was even a very well-known bank advertising their Attractive IRA Rates!!
No wonder the financial industry gets a bad rap, it’s confusing.
Personal finance can be confusing enough, let alone something simple like this.
IRA’s Are Like a Parking Garage
Think of a parking garage a second. Some garages make you pay on the way in, while others make you pay on the way out.
Also, what kind of vehicles can you park in that garage? Only Chevy’s? Fords?
No, you can park any kind of car you want in that garage. Do you want to park stocks in that garage? Maybe you want to park CD’s in that garage.
The kind of vehicle you park in that garage determines your IRA rate, not the IRA itself. Stocks, bonds, CDs, cash – that’s what gives you your IRA rates.
IRA’s Determine How Your Money Will Be Taxed
IRA’s don’t pay rates – they simply allow your investments to be parked in a pre-tax or after-tax way, in other words, IRA’s determine how your money will be taxed.
Let’s go back to the parking garage analogy. If you park your vehicle in the “Pay First” garage, you will have already paid your taxes up front. So when you exit the garage and pull your vehicle out you do not have to pay again – you’ve already paid them.
That’s what a Roth IRA does for you – it allows you to put in after-tax money, lets it grow tax-deferred and then allows you to pull your money out completely tax free.
On the other hand, a regular IRA says you can come on in to the garage with no payments up front, but you’ll have to pay to get out of the garage.
When you withdraw your IRA in retirement, you’ll have to pony up for the taxes!
It’s good to park in different garages, that’s called tax diversification. Which IRA account is best for you? That’s a post you can check out here.
So, next time you hear someone mention IRA rates, gently explain to them that IRA’s don’t pay rates, CD’s and savings accounts do.