An IRA is a tax-advantaged account you open at a bank, brokerage, or credit union to hold retirement savings

An Individual Retirement Account (IRA) is a container for money you set aside for retirement. You open it yourself—not through an employer—and you decide how much to put in each year (within legal limits) and what to invest it in. The account grows tax-deferred, meaning you don't pay taxes on the earnings inside it until you withdraw the money, usually after age 59½.

The main appeal is the tax break. Depending on which type of IRA you choose, you may deduct your contributions from your taxable income in the year you make them, or you may pay taxes now and withdraw the money tax-free later. Either way, the money inside the account compounds without being taxed each year—a significant advantage over a regular savings account or taxable brokerage account.

You can hold almost any investment inside an IRA: stocks, bonds, mutual funds, exchange-traded funds (ETFs), or even certificates of deposit (CDs). The account itself is just the structure; the investments are what actually grow your money.

Key Takeaways

  • You open an IRA yourself at a financial institution and contribute money directly; your employer is not involved.
  • The two main types are Traditional IRAs (contributions may be tax-deductible now, withdrawals taxed later) and Roth IRAs (contributions made with after-tax money, withdrawals tax-free in retirement).
  • Annual contribution limits are the same for both types and change yearly; you cannot contribute more than you earned that year.
  • You must wait until age 59½ to withdraw earnings without a 10% penalty, though some exceptions exist for hardship or first-time home purchase.
  • Required Minimum Distributions (RMDs) force you to start withdrawing from Traditional IRAs at age 73, but Roth IRAs have no RMD during your lifetime.

Traditional IRA: Tax deduction now, taxes on withdrawal later

With a Traditional IRA, you contribute money that may be deductible from your income taxes in the year you contribute it. If you earn $50,000 and contribute $7,000 to a Traditional IRA, you may report only $43,000 as taxable income that year (assuming you meet income requirements and have no other retirement plan through work). The $7,000 grows inside the account without being taxed each year.

When you withdraw money in retirement, that withdrawal counts as ordinary income and you pay income tax on it at your current tax rate. If you withdraw $30,000 in a year when you're in the 22% tax bracket, you owe roughly $6,600 in federal tax on that withdrawal. The idea is that you'll be in a lower tax bracket in retirement than you are while working, so you come out ahead.

You must start taking withdrawals at age 73 (this age changed in 2023 under the SECURE 2.0 Act). These are called Required Minimum Distributions (RMDs), and the IRS calculates how much you must withdraw each year based on your age and account balance. If you don't take the full amount, you face a penalty of 25% on the shortfall (reduced to 10% if you correct it within two years).

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

A Roth IRA works in reverse. You contribute money that is not deductible—you pay income tax on it in the year you earn it. But once that money is inside the Roth account, it grows tax-free, and you can withdraw both your contributions and the earnings tax-free after age 59½, as long as the account has been open for at least five years.

The Roth makes sense if you expect to be in a higher tax bracket in retirement, or if you want the flexibility of tax-free withdrawals. You can also withdraw your contributions (not the earnings) at any time without penalty, which gives you some access to your money in an emergency. Roth IRAs also have no Required Minimum Distributions during your lifetime, so you can let the money sit and grow as long as you want.

However, Roth contributions are subject to income limits. If you earn above a certain threshold (which varies by year and filing status), you cannot contribute directly to a Roth IRA. In 2024, for example, the limit phases out for single filers earning between $146,000 and $161,000. There are workarounds, such as the "backdoor Roth" strategy, but they involve extra steps and tax reporting.

Contribution limits and how much you can put in each year

The IRS sets an annual limit on how much you can contribute to an IRA—the same limit applies to both Traditional and Roth accounts. In 2024, the limit is $7,000 per year for people under age 50. If you're 50 or older, you can contribute an additional $1,000 as a "catch-up" contribution, for a total of $8,000.

These limits change periodically. The IRS adjusts them for inflation, usually in $500 increments. You cannot contribute more than you earned in income that year—if you made $5,000 in 2024, you can contribute at most $5,000 to an IRA, even if the legal limit is $7,000.

If you contribute too much, the IRS charges a 6% excise tax on the excess amount each year until you remove it. It's worth checking your contribution room before you deposit money, especially if you have multiple IRAs or if you also contribute to a workplace retirement plan.

How to open an IRA and where to hold it

You open an IRA by contacting a financial institution directly. Banks, credit unions, and brokerages all offer IRAs. You'll fill out an account application (usually online), choose whether you want a Traditional or Roth IRA, and decide what to invest the money in. Some institutions offer a default money market fund or savings option if you haven't decided yet.

Once the account is open, you fund it by transferring money from your checking or savings account, or by having your employer direct a portion of your paycheck there. You can also roll over money from another IRA or from a workplace retirement plan (like a 401(k)) into an IRA—this is called a rollover and has specific rules about timing and tax treatment.

There's no requirement to choose one institution for life. You can open multiple IRAs at different banks or brokerages, though the annual contribution limit applies across all your IRAs combined. Some people maintain separate accounts for different investment strategies or to keep their money organized.

Withdrawals before retirement and the 10% penalty

If you withdraw money from an IRA before age 59½, you generally owe a 10% penalty on the earnings portion of the withdrawal, plus income tax. This is meant to discourage early withdrawal and to keep the account focused on retirement savings. For a Traditional IRA, the entire withdrawal is taxed as income; for a Roth IRA, only the earnings portion is penalized (you can always withdraw your contributions tax and penalty-free).

However, the IRS allows several exceptions to the 10% penalty. You can withdraw without penalty if you use the money to pay for a first-time home purchase (up to $10,000 lifetime), to pay unreimbursed medical expenses above 7.5% of your adjusted gross income, to pay health insurance premiums while unemployed, or to pay for may have access to education expenses. You can also withdraw penalty-free if you become permanently disabled or if you take substantially equal periodic payments over your lifetime.

Even with an exception to the penalty, you still owe income tax on the withdrawal (except for Roth contributions and certain Roth earnings). The penalty is just the extra 10% on top of the regular tax bill.

Rollovers and transfers between accounts

A rollover is when you move money from one retirement account to another. The most common rollover is from a workplace 401(k) to an IRA when you leave a job. You have 60 days to complete the rollover, or the money is treated as a withdrawal and you owe income tax plus the 10% penalty (if you're under 59½).

There are two ways to do a rollover: a direct rollover (the institution sends the money straight to the new account) and an indirect rollover (you receive a check and deposit it yourself). A direct rollover is simpler and avoids the 60-day clock, so it's usually the better choice. If you do an indirect rollover, the institution will withhold 20% of the amount for federal taxes, even though you plan to deposit it all into another retirement account—you'll get that withholding back when you file your taxes, but only if you deposit the full amount within 60 days.

A transfer is different from a rollover. A transfer is when you move money from one IRA to another IRA at a different institution, and the institutions handle it directly. Transfers are not subject to the 60-day rule or the 20% withholding, so they're simpler and lower-risk.

Frequently Asked Questions

Can I have both a Traditional IRA and a Roth IRA at the same time?

Yes, but your annual contribution limit applies across both accounts combined. If the limit is $7,000 and you contribute $4,000 to a Traditional IRA, you can contribute only $3,000 to a Roth IRA that year. You might do this to split your tax treatment—deducting some contributions now and saving some for tax-free growth later.

What happens to my IRA if I die?

Your IRA passes to your beneficiary (whoever you named on the account). Beneficiaries have different withdrawal rules depending on their relationship to you and the type of IRA. A spouse can treat the IRA as their own; other beneficiaries must withdraw the money within a set timeframe, usually 10 years under current rules. The rules are complex, so beneficiaries should contact the financial institution holding the account.

Can I borrow money from my IRA?

Traditional IRAs do not allow loans. Roth IRAs also do not technically allow loans, but you can withdraw your contributions at any time without penalty, which functions similarly. Some workplace retirement plans like 401(k)s do allow loans, but IRAs do not.

What if I have a workplace retirement plan—can I still open an IRA?

Yes, you can open an IRA even if you have a 401(k) or other workplace plan. However, if you have a workplace plan and your income is above a certain threshold, you may not be able to deduct Traditional IRA contributions. Roth IRA contributions are also subject to income limits if you have a workplace plan. Check the current limits based on your income and filing status.

Do I have to invest the money in stocks, or can I just keep it in cash?

You can keep IRA money in cash—many institutions offer money market funds or savings options within an IRA. However, cash typically earns very little interest, so your money grows slowly. Most people invest at least some of their IRA in stocks or bonds to take advantage of long-term growth, but the choice is yours based on your risk tolerance and time horizon.