What Is an IRA: Tax, Pros/Cons, & 401(k) vs IRA


So, what is an IRA?

Individual retirement account (IRA) is a form of savings where you can save, for example, shares and funds. You do not pay any tax on the profits you make. Instead, you pay an annual tax based on the total value of your assets, whether you make a profit or a loss. You do not have to declare the gains or losses you make on your individual retirement account.

The standard income affects your annual tax

The standard income is based on the total value of your assets and is the basis for how much tax you have to pay for your individual retirement account each year.

The standard income is stated in the control information that the investment company (your bank, for example) submits and is pre-filled in your declaration. The tax you have to pay is 30 percent of the standard income.

In other words, you do not pay tax on individual profits, dividends, interest or other returns that you receive from the assets you have in the account.

You can also withdraw money from the account without having to pay tax on the amount withdrawn.

You can not deduct losses or fees

You may not deduct losses that you make on your individual retirement account. Fund fees, custody fees and other expenses that are linked to the assets in your individual retirement account are also not deductible.

Pros & Cons of an IRA

Benefits of an IRA

  • Cheap form of savings if you choose funds with a low fee. The IRA account itself is usually free of charge, but you have to pay other fees depending on which savings you choose to have in your IRA account.
  • Funds and shares can be sold and exchanged without you having to pay tax on the profit. Instead, you pay a tax on the value of your savings every year, a so-called standard tax. The tax to be paid is arranged by your bank, so it is pre-printed in your tax return.
  • An IRA saving can be a better alternative for long-term saving than saving directly in funds and shares due to a lower expected tax.
  • Sales of securities do not need to be declared.

Disadvantages of an IRA

  • You must pay the standard tax even if the value of your account has decreased during the year.
  • You can not deduct tax when you sell fund units or shares at a loss.
  • It is not possible to choose different types of insurance cover.
  • If you want to save in fixed income funds, which have low risk, it is less advantageous. If you choose to save in an individual retirement account, it is therefore more advantageous to save in equity funds, which have a higher risk.
  • This is because fixed income funds generally provide lower value development than equity funds and the standard tax you have to pay must be paid regardless of whether you have had a low, no or negative value development in your IRA account.

What can I save in?

All cash and securities (shares, mutual funds, certificates, derivatives, warrants and structured products, etc.) that are listed on a stock exchange or trading platform can be in your IRA savings.

You can withdraw money from the account completely free and the amounts withdrawn are not taxed. If you own shares in your account, you have the right to attend general meetings and the like as usual.

What can I not save in?

  • Financial instruments that are not traded on a regulated market or trading platform, such as unlisted shares
  • Shares in a company where you and close relatives own more than ten percent of the votes or capital
  • Qualified shares in small companies.
  • A bank can limit your opportunities to choose which securities you want in the account even though the securities are OK by law. Check with your bank so you are sure that the securities you want in the savings form are possible with them.

How does the tax work on an IRA?

Every quarter, the value of your capital is measured and deposits and securities that have been moved into the savings form are added.

25% of this amount is multiplied by the government loan interest rate on November 30 of the year before + 1.00 percentage points.

The sum of this is reported as income from capital and is taxed at 30%.

You do not have to do anything. If you want to bring in savings you already have today, it is taxed first. The price at the time of moving will be the sales value that forms the basis for taxation.

You can not set off gains and losses within IRA, but the standard income that is taxed at 30% can be set off against capital losses and other capital expenses in the income category capital in your tax return.

So it does not matter if you go plus or minus in your savings. All capital is taxed at a flat rate.

Who is suitable for saving in an IRA?

IRA is suitable for private individuals who have a long-term strategy for their savings. If you expect to get a return in the future (2022) that exceeds 0.375% + any fees, the account is a good choice.

However, it is important to remember that the government loan interest rate today is historically low.

A normal interest rate is more around 3-4%, so expect this in the long run. This makes IRA less good if you intend to save in a regular bank account with a low interest rate. Then it is better to save as usual.

FAQ – Frequently Asked Questions about IRA

1. What is IRA?

IRA is an abbreviation for individual retirement account and is a simple and flexible way to trade securities. The savings form was launched in America the year 1998 followed by the 401(k) in 2006.

2. How do I open an individual retirement account?

You open the account with a bank or stockbroker.

3. What does an IRA cost?

The account is normally free but the banks have the right to charge a fee if they wish. As usual, the bank charges fees for the purchase and sale of securities, so-called brokerage.

4. Can you move your account?

The account can normally be moved from one bank to another without triggering additional tax. However, it is possible that a relocation fee is charged by the bank you are moving from.

5. What applies in the event of death?

Normal inheritance rules apply in the event of death.

Conclusion

For most people, IRA will be the most profitable account type. It is also the easiest because you do not have to declare your business.

IRA was developed with the intention of making saving and investing easier for small savers, which they have succeeded well with.

Nowadays, IRA is the most popular form of investing for small savers who want to save in shares long-term.

Sources

https://www.jstor.org/stable/2117770

https://academic.oup.com/qje/article-abstract/105/3/661/1864586

https://www.journals.uchicago.edu/doi/abs/10.1086/NTJ41791932

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3789270

https://www.nber.org/papers/w4900

https://www.journals.uchicago.edu/doi/abs/10.1086/NTJ41788845?journalCode=ntj

https://www.journals.uchicago.edu/doi/abs/10.1086/tpe.3.20061782

https://www.degruyter.com/document/doi/10.7208/9780226241784-004/html

https://www.aeaweb.org/articles?id=10.1257/jep.10.4.73

https://www.jstor.org/stable/42912342

Kevin

This article has been reviewed by our editorial board and has been approved for publication in accordance with our editorial policies.

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