An IRA is a savings account the government lets you use tax-free or tax-deferred to save for retirement

An Individual Retirement Account (IRA) is a bank or investment account you open in your own name to set aside money for retirement. The government does not contribute to it — you do, from your own income. What makes an IRA different from a regular savings account is the tax treatment: depending on which type you choose, you either pay no tax on the money you put in, or you pay no tax on the growth, or both. The catch is that you cannot withdraw the money before age 59½ without a penalty in most cases.

There are two main types: a Traditional IRA and a Roth IRA. They work in opposite directions. With a Traditional IRA, you may deduct what you contribute from your taxable income in the year you contribute it, but you pay income tax on the money when you withdraw it in retirement. With a Roth IRA, you contribute money that has already been taxed, but the withdrawals in retirement are tax-free. Which one makes sense depends on whether you think your tax rate will be higher now or later.

Key Takeaways

  • You can open an IRA at a bank, credit union, or brokerage firm, and you control what happens to the money inside it.
  • A Traditional IRA may lower your taxes now; a Roth IRA may lower your taxes in retirement, and the choice depends on your current income and tax bracket.
  • 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 before age 59½ without owing a 10 percent penalty and income tax, with narrow exceptions for hardship, first-time home purchase, or education costs.
  • If your employer offers a 401(k) or similar plan, you can have both that plan and an IRA, but contribution limits are separate.

Traditional IRA: Tax deduction now, taxes on withdrawal later

With a Traditional IRA, you contribute pre-tax dollars — meaning you can deduct the contribution from your income on your tax return for that year. If you earn $60,000 and contribute $7,000 to a Traditional IRA, you report only $53,000 as taxable income. That deduction lowers your tax bill immediately.

The money inside the account grows without being taxed each year. When you reach age 59½ and start withdrawing, you pay ordinary income tax on every dollar you take out. The IRS also requires you to start taking withdrawals at age 73 (as of 2023; this age changes under current law). These are called Required Minimum Distributions (RMDs), and if you do not take them, you owe a penalty.

A Traditional IRA makes the most sense if you expect to be in a lower tax bracket in retirement than you are now — for example, if you are working full-time at a high salary but plan to retire and live on less.

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

With a Roth IRA, you contribute money you have already paid income tax on. You get no deduction on your tax return. But the growth inside the account is never taxed, and withdrawals in retirement are completely tax-free.

Roth IRAs have no Required Minimum Distributions during your lifetime, which means you can leave the money untouched as long as you want and pass it to heirs tax-free. You can also withdraw your contributions (not the earnings) at any time without penalty, which gives you more flexibility than a Traditional IRA.

There is an income limit for Roth contributions. If your income is above a certain threshold, you cannot contribute directly to a Roth IRA. For 2024, the limit begins to phase out at $146,000 for single filers and $230,000 for married couples filing jointly, but these numbers change each year. If your income is too high, you may be able to use a "backdoor Roth" strategy, which involves contributing to a Traditional IRA and then converting it to a Roth, though this has its own rules and tax consequences.

Where to open an IRA and what you can invest in

You can open an IRA at almost any financial institution: a bank, credit union, brokerage firm, or investment company. The institution holds the account and the money inside it. You choose what to invest the money in — savings accounts, certificates of deposit (CDs), stocks, bonds, mutual funds, or exchange-traded funds (ETFs), depending on what the institution offers.

Some people use IRAs as simple savings accounts, keeping the money in a high-yield savings account or CD inside the IRA wrapper. Others use them to buy and hold stocks or mutual funds. The tax benefit applies no matter what you invest in, as long as the money stays in the IRA.

You can have more than one IRA, but your total contributions across all IRAs in a single year cannot exceed the annual limit. If you have a Traditional IRA and a Roth IRA, the $7,000 limit (or $8,000 if you are 50 or older) applies to the combined total.

Contribution limits and catch-up contributions for people 50 and older

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 additional $1,000 per year, for a total of $8,000. These limits change periodically; the IRS adjusts them for inflation.

You can only contribute money you actually earned that year. If you earned $5,000 in income, you cannot contribute $7,000 to an IRA. If you are married and your spouse has no income, you can open a spousal IRA in their name and contribute on their behalf, as long as your combined household income is high enough.

You can contribute to an IRA right up until the tax filing deadline for that year, which is usually April 15 of the following year. If you turn 50 during the year, you can make the catch-up contribution for that year.

Early withdrawal penalties and the exceptions that exist

If you withdraw money from an IRA before age 59½, you generally owe a 10 percent penalty plus income tax on the amount withdrawn. This is a steep cost, and it is why IRAs are meant for long-term retirement saving.

There are narrow exceptions where you can withdraw early without the 10 percent penalty (though you still owe income tax on Traditional IRA withdrawals). These include: withdrawals for a first-time home purchase (up to $10,000 lifetime), may have access to education expenses, unreimbursed medical expenses above a certain threshold, health insurance premiums if you are unemployed, and distributions due to disability or medical hardship. Roth IRAs also let you withdraw your contributions (not earnings) at any time without penalty.

If you need access to your money before retirement, an IRA may not be the right tool. A regular savings account or CD outside an IRA gives you full access without penalties.

IRAs versus employer retirement plans like 401(k)s

If your employer offers a 401(k), 403(b), or similar plan, you can have both that plan and an IRA at the same time. They are separate accounts with separate contribution limits. In 2024, you can contribute up to $23,500 to a 401(k) and up to $7,000 to an IRA in the same year.

However, if you have access to an employer plan, there are income limits on whether you can deduct a Traditional IRA contribution. If you earn above a certain threshold and your employer offers a plan, you may not be able to deduct your Traditional IRA contribution, even though you can still make the contribution. A Roth IRA has its own income limits that are separate from employer plan access.

Many people use an IRA as a supplement to an employer plan, especially if they have already maxed out their 401(k) contribution or if they are self-employed and want a simpler option than a Solo 401(k) or SEP IRA.

Frequently Asked Questions

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

Yes. Your combined contributions to both accounts cannot exceed the annual limit ($7,000 or $8,000 if you are 50 or older), but you can split that amount between them however you want. Some people use both to diversify their tax treatment in retirement.

What happens to my IRA if I die?

Your IRA passes to your named beneficiary outside of probate. The beneficiary can withdraw the money, though they may owe income tax depending on the type of IRA and their relationship to you. Roth IRAs are often better for heirs because withdrawals are tax-free.

Can I move money from a 401(k) into an IRA?

Yes, through a process called a rollover. You can roll a 401(k) into a Traditional IRA when you leave a job, and you can roll a Roth 401(k) into a Roth IRA. The money moves directly from one institution to the other without you touching it, which avoids taxes and penalties.

What if I contribute too much to my IRA in a year?

If you over-contribute, you owe a 6 percent penalty tax on the excess amount for each year it stays in the account. You can fix this by withdrawing the excess and any earnings on it before your tax filing deadline, which removes the penalty.

Do I need earned income to open an IRA?

Yes. You can only contribute to an IRA if you have taxable income from work — wages, self-employment income, or other earned income. You cannot fund an IRA with investment returns, Social Security, or pension payments.