What an IRA is and what it does

An IRA (Individual Retirement Account) is a bank or investment account you open in your own name, designed to hold money you set aside for retirement. The account itself is just a container — like a savings account — but the government gives it special tax treatment to encourage you to save.

The core idea is simple: you put money in, that money grows over time through interest or investment returns, and you withdraw it after age 59½. The tax benefit is what makes it different from a regular savings account. Depending on which type of IRA you choose, either the money you put in reduces your taxes now, or the money you take out later is tax-free. That tax advantage is the whole reason IRAs exist.

You can open an IRA at a bank, a credit union, or an investment firm. The account is yours alone — your employer does not control it, and it stays with you if you change jobs. You decide how much to contribute each year (within legal limits), and you decide when to withdraw the money after you reach retirement age.

Key Takeaways

  • An IRA is a retirement savings account that gives you a tax break — either when you contribute money or when you withdraw it later, depending on the type.
  • You can open an IRA at a bank or investment firm in your own name, and it belongs to you regardless of where you work.
  • The two main types are Traditional IRAs (where contributions may reduce your taxes now) and Roth IRAs (where withdrawals in retirement are tax-free).
  • You can contribute up to a set dollar limit each year, and you cannot withdraw money penalty-free before age 59½ in most cases.
  • An IRA is separate from a workplace retirement plan like a 401(k), though you can have both at the same time.

Traditional IRA vs. Roth IRA — the two main types

The two types of IRA differ in when you get the tax break. A Traditional IRA lets you deduct your contributions from your income taxes in the year you make them — so if you earn $50,000 and contribute $5,000 to a Traditional IRA, you may only owe taxes on $45,000. The money grows tax-free inside the account, but when you withdraw it in retirement, you pay income tax on the full amount you take out.

A Roth IRA works the opposite way. You contribute money that has already been taxed (you do not get a deduction now), but when you withdraw it in retirement, you owe no taxes on any of it — not on your original contributions and not on the growth. This makes Roth IRAs appealing if you expect to be in a higher tax bracket in retirement, or if you simply prefer knowing your withdrawals will be tax-free.

The choice between them depends on your current income, your expected retirement income, and how long you plan to let the money sit. Many people benefit from having both types, though contribution limits apply across all your IRAs combined.

How much you can contribute each year

The IRS sets a yearly limit on how much you can contribute to an IRA. This limit changes periodically and depends on your age. For 2024, the limit is $7,000 per year if you are under age 50, and $8,000 if you are 50 or older (the extra $1,000 is called a "catch-up contribution"). These limits apply to all your IRAs combined — if you have both a Traditional and a Roth IRA, your total contributions across both cannot exceed the limit.

You do not have to contribute the maximum every year. You can contribute any amount up to the limit, or nothing at all in a given year. However, you cannot contribute more than you earned in income that year — if you made $3,000 in income, you can only contribute $3,000 to an IRA, even if the yearly limit is higher.

The contribution deadline is usually April 15 of the following year (the same as your tax filing deadline), so you have until mid-April 2025 to make contributions for the 2024 tax year.

How the money grows inside an IRA

Once money is in your IRA, it grows through interest, dividends, or investment gains — depending on what you choose to hold inside the account. If you open an IRA at a bank and keep the money in a savings account or certificate of deposit (CD), it earns interest at whatever rate the bank offers. If you open an IRA at an investment firm and buy stocks, bonds, or mutual funds, the account grows through price appreciation and dividend payments.

The key advantage is that this growth happens tax-free inside the account. If you own a stock that doubles in value, you do not owe capital gains tax on that gain while the money stays in the IRA. This tax-free compounding is what allows retirement savings to grow significantly over decades.

You cannot actively trade in and out of investments inside an IRA without tax consequences the way you might in a regular brokerage account. The account is meant to be a long-term holding place, and the tax benefits are designed to encourage you to leave the money alone until retirement.

When you can withdraw money and what happens if you withdraw early

You can withdraw money from your IRA anytime, but the tax consequences depend on your age and the type of IRA. The standard rule is that you can withdraw penalty-free after age 59½. Before that age, withdrawals are subject to a 10% early withdrawal penalty on top of income taxes owed.

There are some exceptions to the early withdrawal penalty. You can withdraw from a Traditional IRA penalty-free (though you still owe income tax) if you are disabled, if you use the money for may have access to medical expenses, or if you are a first-time homebuyer taking up to $10,000 for a down payment. Roth IRAs have additional flexibility: you can always withdraw your original contributions penalty-free at any age, though earnings withdrawn early are still subject to the penalty.

Starting at age 73, you are required to take minimum withdrawals from a Traditional IRA each year (this is called a Required Minimum Distribution, or RMD). Roth IRAs do not have this requirement during your lifetime. If you do not take the required withdrawal, you face a penalty equal to a percentage of the amount you should have withdrawn.

How an IRA differs from a 401(k) or workplace retirement plan

An IRA is an individual account you open yourself, while a 401(k) is a workplace retirement plan your employer offers. The main differences are who sets it up, how much you can contribute, and who can contribute on your behalf.

With a 401(k), your employer administers the plan, and you contribute through payroll deductions — money comes out of your paycheck before you see it. Your employer may also match a portion of your contributions, meaning they add assistance programs to your account. In 2024, you can contribute up to $23,500 to a 401(k) (or $31,000 if you are 50 or older), which is much higher than IRA limits.

An IRA is purely your own. You fund it with money you already have, and no employer contribution is involved. However, you can have both an IRA and a 401(k) at the same time. Many people do: they contribute to their employer's 401(k) to get the employer match, then open an IRA for additional retirement savings. The contribution limits are separate, so you can max out both if your income allows.

How to open an IRA and get your free guide

Opening an IRA takes about 15 to 30 minutes. You choose a financial institution — a bank, credit union, or investment firm — and complete an account application, either online or in person. You will need to provide your name, address, Social Security number, and employment information. Some institutions ask about your investment experience or retirement goals, but these questions do not determine whether you can open the account.

Once the account is open, you fund it by transferring money from a checking or savings account, or by depositing a check. If you are moving money from an existing IRA at another institution, you can request a direct transfer (called a "trustee-to-trustee transfer"), which avoids taxes and penalties. You then decide what to hold in the account — a savings product at a bank, or investments at a brokerage firm.

You do not need to contribute the maximum or even a large amount to start. Many people begin with whatever they can afford and increase contributions over time. The important part is starting early, because the longer money sits in an IRA, the more time compound growth has to work.

Frequently Asked Questions

Can I have both a Traditional IRA and a Roth IRA?

Yes, you can have both at the same time. However, your total contributions across all IRAs combined cannot exceed the yearly limit. If you contribute $4,000 to a Traditional IRA, you can only contribute $3,000 to a Roth IRA that year (assuming the limit is $7,000).

What happens if I do not use all my contribution room in a given year?

Unused contribution room does not roll over to the next year. If you do not contribute the full amount you are allowed in 2024, you cannot make up for it in 2025 by contributing extra. Each year is separate, so it is important to contribute what you can before the deadline.

Can I withdraw my contributions from a Roth IRA without penalty?

Yes. With a Roth IRA, you can withdraw the money you originally contributed at any age without penalty or taxes. You can only withdraw earnings (the growth) penalty-free after age 59½. This makes Roth IRAs more flexible if you need access to your money before retirement.

Do I need earned income to open an IRA?

Yes, you must have earned income (wages, self-employment income, or similar) in the year you contribute. You cannot contribute more than you earned. However, if you are married and your spouse has earned income, your spouse can contribute to an IRA on your behalf under certain conditions.

What is the difference between an IRA and a regular savings account?

A regular savings account has no contribution limits and no age restrictions on withdrawals, but you pay taxes on the interest each year. An IRA has yearly contribution limits and penalties for early withdrawal, but the tax benefits (either now or in retirement) make it more efficient for long-term retirement savings.