First things first: an IRA — actually, “Individual Retirement Arrangement,” though most people call it an account — is not an investment itself. Instead, think of it as a container that can hold any type of investment.

You get to choose the investments that go into your IRA, often with the help of a financial advisor or broker. You can fill it with a mix of things such as stocks, bonds, mutual funds, cash, CDs or annuities — the same things you put in any other type of investment account.

The difference is that because the government wants you to save for retirement, IRAs give you a legal way to keep more of your money from Uncle Sam. Depending on what type you choose, you either save on paying taxes now, or you’ll enjoy tax-free earnings in retirement.

Why do you need one?

An IRA should be considered if you don’t have a 401(k) through your work. But even if you do, an IRA still makes sense. With the future health of Social Security under scrutiny and company pension plans becoming obsolete, relying only on your employer’s plan may not be enough to build the savings you’ll need for retirement.

An IRA gives you more investment choices, too. For example, some 401(k) plans don’t offer index funds, a collection of stocks whose goal is to match the performance of a particular index. Because index funds don’t have active management, many of them offer lower fees.

If you switch jobs, rolling your 401(k) assets into an IRA — rather than into your new employer’s 401(k) — gives you more freedom to choose how to invest your hard-earned money.
Roth vs. Traditional

There are two basic types of IRAs: traditional and Roth. In a traditional IRA, the money you put in is deducted from your taxable income. Once you retire, you’ll pay income taxes on your withdrawals.

If you are an active participant in a company-sponsored plan, then a traditional IRA is deductible only if your income is below certain thresholds: $55,000 to $65,000 for single taxpayers; $89,000 to $109,000 for married filing jointly; and $0 to $10,000 if you’re married filing separately. Deductibility is phased out between those numbers.

With a Roth IRA, your contributions are not tax-deductible, but you get to enjoy your earnings tax free in retirement. To be more specific: All earnings in the account for five years or greater are not subject to federal income taxes if the account has been open for at least five years and you are at least age 59½ when you start making withdrawals. Please consult with a tax adviser for your specific situation.

To be eligible for a Roth IRA, your annual income must be less than $120,000, or $176,000 if you’re married filing jointly. Single filers who earn at least $105,000 and married filing jointly who earn at least $166,000 can’t contribute the full amount.

The 2009 and 2010 maximum total contribution for both kinds of IRAs is $5,000 a year, or $6,000 if you’re age 50 or older.
How to choose?

Which IRA is right for you? Most financial experts say it depends what you think your future tax rate will be.

If you believe income tax rates will rise or that your personal income will go up in retirement, putting you in a higher tax bracket, then choose a Roth and pay taxes on the money now. If you expect to be in a lower tax bracket in retirement — or you don’t qualify for a Roth — a traditional IRA is a good choice.

And remember, no matter which one you choose, both types of IRAs offer a major advantage over almost every other type of account: tax-free money.

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