An IRA is a retirement savings account that gives you tax breaks when you save money for later
IRA stands for Individual Retirement Account. It is a savings account the U.S. government created to encourage people to set aside money for retirement. The main benefit: the money you put in, or the money it earns, gets tax breaks that regular savings accounts do not have. That means more of your money stays in the account instead of going to taxes.
You open an IRA through a bank, credit union, brokerage firm, or investment company. You then decide how much to deposit each year (up to a limit set by the government, which changes yearly). The money sits in the account, grows, and you can withdraw it starting at age 59½ without a penalty. If you withdraw before that age, you usually pay a 10% penalty plus income tax on the money you take out.
There are two main types: a Traditional IRA and a Roth IRA. They work differently, and which one makes sense depends on your income and when you want the tax break.
Key Takeaways
- An IRA is a retirement savings account that offers tax advantages you do not get with a regular savings account.
- You can contribute up to a yearly limit (the amount changes each year and depends on your age), and the money grows tax-deferred or tax-free depending on the type.
- A Traditional IRA may let you deduct your contributions from your taxes now, but you pay taxes when you withdraw in retirement.
- A Roth IRA takes after-tax money now, but withdrawals in retirement are tax-free.
- You can withdraw penalty-free starting at age 59½; withdrawing earlier usually costs you a 10% penalty plus income tax.
How a Traditional IRA works
With a Traditional IRA, you contribute money and may be able to deduct that contribution from your taxable income in the year you make it. That deduction lowers the taxes you owe that year. The money then grows inside the account without being taxed each year—this is called tax-deferred growth. You only pay income tax when you withdraw the money in retirement.
Whether you can deduct your full contribution depends on your income and whether you have access to a workplace retirement plan like a 401(k). If you earn above a certain threshold and have a workplace plan, your deduction phases out or disappears. The income limits change yearly, so you will need to check the current year's limits when you contribute.
Once you turn 73, you must start taking withdrawals from your Traditional IRA. These are called Required Minimum Distributions (RMDs), and the government calculates how much you must take each year based on your age and account balance. If you do not take the full amount, you pay a penalty on the amount you should have withdrawn.
How a Roth IRA works
A Roth IRA works in reverse. You contribute money that you have already paid income tax on—no deduction now. But the money grows tax-free inside the account, and when you withdraw it in retirement, you owe no income tax on any of it: not the contributions, not the earnings. This makes a Roth powerful if you expect to be in a higher tax bracket in retirement or if you simply want tax-free income later.
Roth IRAs have income limits too. If you earn above a certain amount, you cannot contribute directly to a Roth. These limits also change yearly. Unlike a Traditional IRA, you do not have to take Required Minimum Distributions from a Roth during your lifetime, which gives you more control over when and how much you withdraw.
You can withdraw your contributions (the money you put in) from a Roth at any time without penalty or tax. Withdrawing the earnings before age 59½ usually triggers the 10% penalty and income tax, unless you meet a narrow exception like a first-time home purchase or a financial hardship.
Contribution limits and who can open one
The government sets a yearly limit on how much you can contribute to an IRA. For 2024, that limit is $7,000 if you are under 50, and $8,000 if you are 50 or older (the extra $1,000 is called a catch-up contribution). These limits change periodically, so check the current year before you contribute.
You can open an IRA as long as you have earned income—money from a job or self-employment. You cannot open one if you have no income that year. If you are married and your spouse has no income, you may be able to open a Spousal IRA in their name and contribute on their behalf, as long as your combined household income is high enough.
You can have both a Traditional IRA and a Roth IRA, but your total contributions across all IRAs cannot exceed the yearly limit. For example, if the limit is $7,000, you cannot put $7,000 in a Traditional IRA and another $7,000 in a Roth—your combined contributions must stay at or below $7,000.
Where to open an IRA and what to invest in
You can open an IRA at most banks, credit unions, and investment firms. Common places include Vanguard, Fidelity, Charles Schwab, and your own bank. Each institution offers different investment options inside the IRA—stocks, bonds, mutual funds, index funds, or even a simple savings account. The IRA itself is just the container; what you invest in is up to you.
If you do not know what to invest in, many firms offer target-date funds. You pick the year you plan to retire, and the fund automatically adjusts its mix of stocks and bonds as you get closer to that date. This removes the guesswork and is a reasonable starting point for someone new to investing.
Opening an IRA usually takes 10 to 20 minutes online. You will need your Social Security number, date of birth, and bank account information if you want to fund it by transfer. Some institutions let you open the account and fund it the same day; others may take a few business days to process.
Tax implications and withdrawal rules
The tax treatment of your IRA depends on which type you have and when you withdraw. With a Traditional IRA, every dollar you withdraw is taxed as ordinary income in the year you withdraw it. If you withdraw before 59½, you also pay a 10% early withdrawal penalty on top of the income tax, unless you meet a narrow exception.
Common exceptions to the early withdrawal penalty include: a first-time home purchase (up to $10,000 lifetime), paying for higher education expenses, paying unreimbursed medical expenses above a certain threshold, or withdrawing due to disability or medical hardship. Even with an exception, you still owe income tax on the withdrawal—the penalty is waived, but the tax is not.
With a Roth IRA, you can withdraw your contributions anytime without tax or penalty. Withdrawals of earnings before 59½ are taxed and penalized unless you meet an exception. At 59½ or later, both contributions and earnings come out tax-free if the account has been open for at least five years.
Traditional IRA vs. Roth IRA at a glance
The table below shows the key differences between the two account types so you can see which features matter most to your situation.
| Feature | Traditional IRA | Roth IRA |
|---|---|---|
| Contribution tax deduction | May be deductible now (depends on income and workplace plan) | No deduction; contributions are after-tax |
| Growth | Tax-deferred | Tax-free |
| Withdrawals in retirement | Taxed as ordinary income | Tax-free (if account is 5+ years old) |
| Required Minimum Distributions | Must start at age 73 | None during your lifetime |
| Income limits | Deduction phases out above certain income | Cannot contribute above certain income |
| Early withdrawal of contributions | Taxed and penalized | Tax-free and penalty-free |
A Traditional IRA makes sense if you want to lower your taxes this year and expect to be in a lower tax bracket in retirement. A Roth makes sense if you expect to be in a higher tax bracket later or want tax-free withdrawals with no Required Minimum Distributions.
Frequently Asked Questions
Can I have both a Traditional IRA and a Roth IRA?
Yes, but your total contributions to both accounts in a single year cannot exceed the yearly limit. If the limit is $7,000, you could put $4,000 in a Traditional IRA and $3,000 in a Roth, but not $7,000 in each. This rule keeps people from doubling their tax-advantaged savings.
What happens if I withdraw money before age 59½?
You pay a 10% penalty plus income tax on the withdrawal, unless you meet a narrow exception. Exceptions include a first-time home purchase (up to $10,000), education expenses, medical hardship, or disability. Even with an exception, you still owe income tax—only the penalty is waived.
Can I roll over a 401(k) into an IRA?
Yes. When you leave a job, you can move your 401(k) balance into a Traditional IRA without paying taxes or penalties, as long as you do it as a direct transfer (the money goes straight from the 401(k) plan to the IRA). This is called a rollover. If the money passes through your hands first, you have 60 days to deposit it in the IRA or you owe taxes and penalties.
Do I need earned income to open an IRA?
Yes. You must have earned income—from a job or self-employment—in the year you contribute. If you have no income, you cannot contribute. The only exception is a Spousal IRA, where a working spouse can contribute on behalf of a non-working spouse.
What is the difference between an IRA and a 401(k)?
An IRA is an individual account you open yourself; a 401(k) is a workplace plan your employer offers. 401(k)s usually have higher contribution limits and may include employer matching. IRAs have lower limits but more investment choices and more flexibility. Many people have both.