What an IRA is and how money moves through it

An IRA is a savings account the government created specifically for retirement. You open it at a bank, credit union, or brokerage firm. You put money in. That money grows over time through interest, dividends, or investment gains. When you turn 59½, you can take the money out without penalty. That is the basic shape of it.

The account itself does not do anything special with your money. A bank IRA works like a regular savings account — your money sits there earning interest at whatever rate the bank pays. A brokerage IRA works like an investment account — your money buys stocks, bonds, or mutual funds that go up or down in value. The IRA is just the container. The rules around it are what make it different from a regular account.

You fund an IRA with money you already have — from your paycheck, a bonus, a tax refund, money you inherited. The bank or brokerage does not give you the money. You give them the money, and they hold it in the IRA. That is the deposit.

Key Takeaways

  • An IRA is a retirement savings account you open at a bank or brokerage and fund with your own money, which then grows through interest or investments until you withdraw it at 59½ or later.
  • The two main types are Traditional IRAs, where contributions may lower your taxes now but withdrawals are taxed later, and Roth IRAs, where contributions are made with after-tax money but withdrawals are tax-free.
  • You can deposit a limited amount each year — the limit changes annually and depends on your age — and the IRS enforces these limits strictly.
  • If you withdraw money before 59½, you typically owe income tax on the withdrawal plus a 10 percent penalty, with a few narrow exceptions like medical hardship or first-time home purchase.
  • An IRA is separate from your employer's retirement plan, and you can have both at the same time.

Traditional IRA versus Roth IRA: the tax difference

The two main types of IRAs differ in when you pay taxes. A Traditional IRA lets you deduct your contributions from your income taxes in the year you make them — meaning if you earn $50,000 and put $5,000 in a Traditional IRA, you may only owe taxes on $45,000. But when you withdraw the money in retirement, you pay income tax on every dollar you take out. The money grew tax-free inside the account, but the government taxes you when you use it.

A Roth IRA works backward. You contribute money that has already been taxed — you do not get a tax deduction now. But when you withdraw the money in retirement, you owe no taxes on it, and you owe no taxes on the growth either. The money grew tax-free inside the account, and it stays tax-free when you take it out.

Which one makes sense depends on whether you think your tax rate will be higher now or in retirement. If you are young and in a low tax bracket, a Roth often makes more sense — you pay taxes at a low rate now and avoid them later. If you are older, earning a high income, and expect to be in a lower tax bracket in retirement, a Traditional IRA often makes more sense — you cut your taxes now and pay a lower rate later. But both are legitimate paths.

How much you can deposit each year

The IRS sets a yearly limit on how much you can put into an IRA. That limit changes most years. For 2024, the limit is $7,000 if you are under 50. If you are 50 or older, you can deposit an extra $1,000 — $8,000 total — called a catch-up contribution. These numbers shift annually, and your bank or brokerage will tell you the current limit when you open the account.

The limit applies across all your IRAs combined. If you have a Traditional IRA and a Roth IRA at two different banks, you cannot put $7,000 in each one. You can put $7,000 total across both accounts. The IRS tracks this, and if you go over, you owe a penalty on the excess.

You can deposit money at any time during the year, or you can wait until the tax deadline — usually April 15 of the following year — to make a deposit for the previous year. Many people make their deposits in January or February, but the deadline gives you flexibility if you do not have the money ready.

What happens to your money while it sits in the IRA

Inside a bank IRA, your money earns interest just like it would in a regular savings account. The bank pays you a rate, compounds it daily or monthly, and your balance grows slowly and predictably. You can see the interest added to your account statement each month.

Inside a brokerage IRA, your money buys investments — usually stocks, bonds, or mutual funds. Those investments go up and down in value. If you buy a stock mutual fund and the market rises 10 percent, your account grows 10 percent. If the market falls 5 percent, your account falls 5 percent. You own the investments; the brokerage just holds them in the IRA wrapper.

In both cases, you do not pay taxes on the growth while the money is inside the IRA. Interest and investment gains accumulate tax-free. That is the main benefit of the account structure. In a regular savings account or brokerage account, you would owe taxes on interest and gains each year. In an IRA, you do not — not until you withdraw.

When you can withdraw money and what it costs

You can withdraw money from your IRA anytime. There is no rule against it. But there are tax consequences if you withdraw before 59½.

If you withdraw before 59½, you owe income tax on the withdrawal, plus a 10 percent early withdrawal penalty. So if you withdraw $10,000 from a Traditional IRA at age 40, you owe income tax on that $10,000 plus $1,000 in penalty. That is a steep cost for accessing your own money early.

A few situations let you withdraw early without the 10 percent penalty, though you still owe income tax. These include a serious medical expense, a permanent disability, health insurance premiums while unemployed, or a first-time home purchase (up to $10,000 lifetime). The rules are narrow and specific — the IRS does not consider most reasons valid. You would need to document the hardship and file the right tax form.

At 59½, you can withdraw as much as you want, whenever you want, with no penalty. You still owe income tax on Traditional IRA withdrawals (but not Roth withdrawals), but the 10 percent penalty goes away.

Required minimum distributions and age 73

Once you turn 73, the IRS requires you to withdraw a minimum amount from your Traditional IRA each year. This is called a required minimum distribution, or RMD. The amount depends on your age and your account balance — older people must withdraw a larger percentage. The IRS publishes a table each year that tells you the exact amount.

If you do not take the RMD, you owe a penalty — 25 percent of the amount you should have withdrawn (or 10 percent if you correct it within two years). That is a serious penalty. You have to track this yourself; the bank does not force you to withdraw.

Roth IRAs do not have required minimum distributions while you are alive. You can leave the money in the account as long as you want. This is one reason some people prefer Roths — more control over when to take the money out.

How an IRA differs from an employer retirement plan

Many employers offer a 401(k) or similar plan. An IRA is separate. You can have both at the same time. They are different accounts with different rules and different contribution limits.

An employer plan is funded through your paycheck — your employer deducts money before you see it and puts it into the plan. An IRA is funded by you, with money you already have. An employer plan often includes a match — your employer puts in money too. An IRA does not; it is just your money.

The contribution limits are different. For 2024, you can put up to $23,500 in a 401(k) but only $7,000 in an IRA. If you have both, you are not choosing between them — you are using both, up to their separate limits.

Many people use an IRA as a supplement to an employer plan, especially if they have already maxed out the employer plan or if their employer does not offer one. Some people use an IRA as their only retirement savings if they are self-employed or work for a small company with no plan.

Rolling over money from an old employer plan into an IRA

When you leave a job, you can move the money from your employer's 401(k) into an IRA. This is called a rollover. You do not touch the money yourself — the old employer sends it directly to the new IRA. You avoid taxes and penalties because the money moves directly from one retirement account to another.

A rollover is useful because IRAs often have lower fees and more investment choices than employer plans. You can consolidate money from multiple old jobs into one IRA, making it easier to manage. The money keeps growing tax-free, just as it did in the employer plan.

You can also do a rollover in reverse — move money from an IRA back into an employer plan if the plan allows it. This is less common but useful if you want to delay required minimum distributions or if you need access to the money before 59½ (some employer plans allow loans; IRAs do not).

Frequently Asked Questions

Can I have more than one IRA?

Yes, you can have multiple IRAs at different banks or brokerages. But your total contributions across all of them cannot exceed the yearly limit. If you have a Traditional IRA at one bank and a Roth IRA at another, you can put $7,000 total between them, not $7,000 in each one.

What happens to my IRA if I die?

Your IRA passes to whoever you named as the beneficiary on the account. That person 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. The beneficiary designation overrides your will, so make sure it is current.

Can I withdraw money from a Roth IRA before 59½ without penalty?

You can withdraw your contributions (the money you put in) anytime without tax or penalty. You cannot withdraw the growth without penalty before 59½, with the same narrow exceptions as a Traditional IRA. This makes Roths more flexible if you need access to your own deposits.

What if I earn too much money to open a Roth IRA?

Roth IRAs have income limits — if you earn above a certain amount, you cannot contribute directly. For 2024, the limit phases out starting around $146,000 for single filers. If you exceed the limit, you can still open a Traditional IRA, or you can do a "backdoor Roth" by contributing to a Traditional IRA and converting it to a Roth, though this has tax complications you should discuss with a tax professional.

Do I need to report my IRA on my taxes?

You report IRA contributions on your tax return if you are deducting them (Traditional IRA). You report withdrawals on your tax return. The bank sends you a form each year showing interest earned or distributions taken. You do not need to report the account itself, just the tax-relevant activity.