An IRA is a retirement savings account you open yourself, not through an employer

An IRA (Individual Retirement Account) is a bank or investment account you set up on your own to save for retirement. Unlike a 401(k), which your employer sponsors and often matches contributions to, an IRA is yours alone from the start. You choose the financial institution, you decide how much to contribute each year (within legal limits), and you control where the money goes.

The main appeal of an IRA is the tax break. Depending on which type you open, your contributions may reduce your taxable income in the year you make them, or your withdrawals in retirement may be tax-free. That tax advantage is the whole reason IRAs exist — the government wants to encourage people to save for retirement on their own.

IRAs come in two main flavors: Traditional and Roth. The difference is when you get the tax break — now or later — and that choice shapes how the account works for the rest of your life.

Key Takeaways

  • A Traditional IRA lets you deduct contributions from your taxes in the year you make them, but you pay income tax on withdrawals in retirement.
  • A Roth IRA takes contributions in after-tax dollars, but withdrawals in retirement are completely tax-free.
  • You can open an IRA at a bank, credit union, or brokerage firm, and you can have both a Traditional and a Roth IRA at the same time.
  • For 2024, you can contribute up to $7,000 per year to an IRA if you are under 50, or $8,000 if you are 50 or older.
  • You cannot withdraw money from an IRA before age 59½ without paying a 10 percent penalty, with some exceptions for hardship.

Traditional IRA: Tax deduction now, taxes on withdrawal later

A Traditional IRA works like this: you contribute money, and that contribution amount reduces your taxable income for that year. If you earn $60,000 and contribute $7,000 to a Traditional IRA, you only report $53,000 as taxable income. That means a smaller tax bill right away.

The money grows inside the account tax-free. You do not pay taxes on interest, dividends, or investment gains while the money sits there. But when you withdraw money in retirement — starting at age 59½ — that withdrawal is treated as ordinary income and you pay income tax on it at your current tax rate.

A Traditional IRA makes sense if you expect to be in a lower tax bracket in retirement than you are now. You get the tax break when your income is high, and you pay taxes later when your income (and tax rate) is lower.

Roth IRA: No tax deduction now, tax-free withdrawals later

A Roth IRA is the opposite. You contribute money that has already been taxed — it does not reduce your current year's taxes. But the money grows tax-free inside the account, and when you withdraw it in retirement, you owe nothing. The entire withdrawal is yours to keep.

A Roth IRA makes sense if you expect to be in a higher tax bracket in retirement, or if you straightforward want the certainty of knowing exactly how much you will have to spend (because there is no tax surprise at withdrawal time). Roth IRAs are also more flexible: you can withdraw your contributions (not the earnings) at any time without penalty, which makes them useful as an emergency backup.

One catch: if your income is too high, you cannot contribute to a Roth IRA directly. The income limits change each year. For 2024, single filers begin to lose the ability to contribute at $146,000 in income and cannot contribute at all above $161,000. Married filers have higher limits. If you exceed the limit, you can still use a "backdoor Roth" strategy, but that involves extra steps and tax paperwork.

Where to open an IRA and what it holds

You can open an IRA at almost any financial institution: a bank, credit union, brokerage firm, or investment company. Common places include Fidelity, Vanguard, Charles Schwab, and your own bank. Each charges different fees and offers different investment options, so it is worth comparing before you choose.

Inside an IRA, you can hold cash, stocks, bonds, mutual funds, exchange-traded funds (ETFs), or certificates of deposit (CDs). Some institutions limit your choices — a bank IRA might only offer CDs and savings accounts — while a brokerage lets you pick individual stocks or funds. You decide what to invest in based on your comfort level and how long until retirement.

You can have both a Traditional IRA and a Roth IRA at the same time. However, your total contributions across all IRAs in a single year cannot exceed the annual limit ($7,000 for 2024 if you are under 50).

Annual contribution limits and catch-up contributions

For 2024, you can contribute up to $7,000 per year to an IRA if you are under age 50. If you are 50 or older, you can contribute an extra $1,000 per year — a total of $8,000 — through a "catch-up contribution." This extra allowance exists to help people who started saving late to build up their retirement nest egg faster.

You can contribute to an IRA only if you have earned income (wages, self-employment income, or similar). You cannot contribute if your only income is from investments or Social Security. The contribution must be made by the tax filing important date for that year, which is usually April 15 of the following year.

These limits are set by law and change occasionally. The IRS announces new limits each year, so if you are planning to contribute, check the current year's limit before you deposit money.

Withdrawal rules and the 10 percent early withdrawal penalty

You can withdraw money from an IRA starting at age 59½ without penalty. Before that age, withdrawals are subject to a 10 percent penalty on top of income tax. For example, if you withdraw $10,000 from a Traditional IRA at age 45, you pay a $1,000 penalty plus income tax on the full $10,000.

Some situations waive the 10 percent penalty. You can withdraw early without penalty to pay for a first home (up to $10,000 lifetime), to cover unreimbursed medical expenses, to pay health insurance premiums while unemployed, or to pay for higher education expenses. Disability and medical hardship may also may have access to. However, you still owe income tax on the withdrawal — the penalty is waived, but the tax is not.

Roth IRAs have a special rule: you can withdraw your contributions (the money you put in) at any time without penalty or tax. You can only withdraw earnings (the growth) penalty-free after age 59½ and if the account has been open for at least five years.

Required minimum distributions at age 73

Starting at age 73, you must begin withdrawing money from a Traditional IRA each year. The IRS calls this a required minimum distribution (RMD). The amount is calculated based on your age and account balance, and it increases each year as you get older. If you do not take the full amount, you pay a penalty on the shortfall.

Roth IRAs do not have required minimum distributions during the account holder's lifetime. You can leave the money in the account to grow as long as you live, which makes Roths useful for people who do not need the money in retirement or who want to leave a larger inheritance.

If you have both a Traditional IRA and a SEP IRA or straightforward IRA (employer plans), the RMD rules are more complex. You calculate the RMD for each account separately but can withdraw the total from any one account.

IRA versus 401(k): when you might need both

If your employer offers a 401(k), you might wonder whether to use that or an IRA instead. The answer is often both. Many people contribute to their employer's 401(k) first (especially if the employer matches), then open an IRA to save additional retirement money beyond the 401(k) limit.

An IRA gives you more control over investments and lower fees than many 401(k) plans. A 401(k) often has higher contribution limits and an employer match, which is information programs. The best strategy depends on your employer's match, the fees in your 401(k), and how much you want to save.

If you leave a job, you can roll over your 401(k) balance into an IRA. This move lets you consolidate accounts and often gives you more investment choices and lower fees. A rollover is not a taxable event if you do it correctly — the money moves directly from the 401(k) custodian to the IRA custodian.

Frequently Asked Questions

Can I have an IRA if I am self-employed?

Yes. Self-employed people can open a Traditional or Roth IRA just like anyone else. You can also open a SEP IRA or Solo 401(k), which allow much higher contributions if you have self-employment income. A SEP IRA lets you contribute up to 25 percent of your net self-employment income, up to a much higher annual limit than a regular IRA.

What happens to my IRA if I die?

Your IRA passes to the beneficiary you named when you opened the account. The beneficiary can withdraw the money, roll it into their own IRA, or take distributions over time depending on their relationship to you and the type of IRA. Naming a beneficiary is crucial — if you do not name one, the account goes through your estate, which is slower and more expensive.

Can I withdraw from my Roth IRA contributions without penalty?

Yes. You can withdraw the contributions you made to a Roth IRA at any time, at any age, without penalty or tax. You cannot withdraw the earnings (investment growth) without penalty until age 59½, and only if the account has been open for at least five years. This flexibility makes Roth IRAs useful as an emergency fund.

What is the difference between a SEP IRA and a regular IRA?

A SEP IRA is designed for self-employed people and small business owners. It allows much higher contributions — up to 25 percent of net self-employment income or $69,000 per year (2024) — compared to $7,000 for a regular IRA. The tradeoff is that SEP IRAs are simpler to set up but offer fewer investment options at some institutions.

Can I deduct my IRA contribution if I have a 401(k) at work?

It depends on your income. If you have a 401(k) at work, your ability to deduct a Traditional IRA contribution phases out at higher income levels. For 2024, single filers begin to lose the deduction at $77,000 income and cannot deduct at all above $87,000. Married filers have higher limits. Roth IRA contributions have separate income limits that are higher.