An IRA is a tax-advantaged savings account designed specifically for retirement

An IRA (Individual Retirement Account) is a bank or investment account that lets you set aside money for retirement while getting tax breaks the government offers. The tax break is the whole point: depending on which type of IRA you open, you either pay no taxes on the money you put in, or you pay no taxes on the money you take out later. That difference in timing is what separates the two main kinds.

You open an IRA through a bank, brokerage, credit union, or investment company—not through your employer. You control the account, you decide how much to put in each year (up to a legal limit), and you decide what to do with the money inside it. The account sits there, separate from your checking account and your employer's retirement plan, if you have one.

The catch is that the government wants this money to stay put until you are 59½ years old. If you take it out earlier, you usually pay a 10% penalty on top of income taxes. There are a few exceptions—first-time home purchase, medical hardship, certain education costs—but they are narrow. The account is built to discourage you from touching the money before retirement.

Key Takeaways

  • An IRA is a retirement savings account you open yourself, not through an employer, and the government gives you a tax break to use it.
  • A Traditional IRA lets you deduct contributions from your taxes now, but you pay income tax when you withdraw the money in retirement.
  • A Roth IRA takes contributions after you pay taxes on them, but withdrawals in retirement are tax-free.
  • You can contribute up to a set amount each year (the limit changes annually), and you cannot withdraw without penalty before age 59½ in most cases.
  • An IRA is separate from a 401(k) or other employer plan, and you can have both at the same time.

Traditional IRA: Tax deduction now, taxes later

A Traditional IRA lets you deduct your contributions from your income taxes in the year you make them. If you earn $50,000 and put $6,500 into a Traditional IRA, you report only $43,500 as taxable income that year. The money grows inside the account without being taxed each year. When you turn 59½ and start withdrawing, you pay ordinary income tax on whatever you take out.

This works well if you expect to be in a lower tax bracket in retirement than you are now—which is true for many people. You save taxes at a higher rate today and pay them at a lower rate later. The trade-off is that you do not know what tax rates will be in 20 or 30 years, and the government requires you to start taking withdrawals at age 73 (this age was raised from 72 in 2023). Those required withdrawals are called RMDs (Required Minimum Distributions), and if you do not take them, the penalty is steep: 25% of the amount you should have withdrawn.

You can contribute to a Traditional IRA at any age, but there are income limits if you also have a 401(k) or similar plan through work. If your income is too high, you cannot deduct the full contribution. The IRS publishes these limits each year, and they depend on your filing status and whether you have an employer plan.

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

A Roth IRA works backward. You contribute money you have already paid taxes on—no deduction today. The money grows tax-free inside the account. When you withdraw in retirement, you owe nothing, not even income tax. For many people, especially younger workers who expect higher earnings later, this is the better deal.

The Roth has no required withdrawals at any age. You can leave the money in the account as long as you want, and your heirs inherit it tax-free. You can also withdraw your contributions (not the earnings) at any time without penalty, which gives you a small safety valve if you need the money. That said, the earnings are still locked until 59½.

Roth IRAs have income limits too. If you earn above a certain threshold, you cannot contribute directly. For 2024, the phase-out begins around $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 have other options: a backdoor Roth (a legal workaround involving a Traditional IRA) or a Roth conversion (moving money from a Traditional IRA to a Roth and paying taxes on it).

How much you can contribute each year

The IRS sets an annual contribution limit for IRAs. For 2024, you can put up to $7,000 into an IRA (either Traditional or Roth, or split between them). If you are 50 or older, you can add an extra $1,000 as a "catch-up" contribution, for a total of $8,000. These limits change most years, usually rising by $500 increments when inflation warrants it.

You can only contribute money you actually earned that year. If you earned $3,000 from a job, you can contribute at most $3,000 to an IRA, not the full $7,000. Spouses with no income can sometimes contribute to a spousal IRA if their partner earned enough, but the rules are specific.

You have until the tax filing deadline (usually April 15 of the following year) to make a contribution for the previous year. If you miss that deadline, you cannot go back and make it up, so the deadline matters.

IRA vs. 401(k): When you have both

An IRA and a 401(k) are separate accounts that serve the same goal but work differently. A 401(k) is offered by your employer; an IRA is something you open on your own. You can have both at the same time. Many people do: they contribute to their employer's 401(k) to get the company match (assistance programs), then open an IRA for additional retirement savings.

A 401(k) has higher contribution limits—$23,500 for 2024, compared to $7,000 for an IRA—but it also has required withdrawals starting at 73. A Traditional 401(k) works like a Traditional IRA (tax deduction now, taxes later), and a Roth 401(k) works like a Roth IRA (no deduction, tax-free withdrawals). Some employers offer both options.

If you have a 401(k) through work, it can affect whether you can deduct a Traditional IRA contribution. The income limits tighten if you have an employer plan. This is one reason people sometimes roll a 401(k) into an IRA when they leave a job—to simplify their accounts and potentially lower fees.

What you can invest in inside an IRA

An IRA is just a container. Inside it, you can hold stocks, bonds, mutual funds, exchange-traded funds (ETFs), or even some alternative investments depending on where you open the account. A bank IRA might offer only savings accounts and CDs. A brokerage IRA gives you access to thousands of stocks and funds. Some IRAs allow real estate or precious metals, though these are less common and come with extra rules.

The tax benefits apply no matter what you invest in. If you buy a stock inside an IRA and it doubles, you do not pay capital gains tax on that gain (in a Traditional IRA, you pay tax on the withdrawal; in a Roth, you pay nothing). This is one reason IRAs are powerful: the tax shelter applies to all the growth, not just your initial contribution.

You can move money between investments inside the same IRA without triggering taxes. You can also transfer an IRA from one bank or brokerage to another—this is called a rollover or transfer—without penalty, as long as you do it correctly. If you do it wrong (taking the money out and depositing it yourself instead of having the institutions transfer it directly), you can face taxes and penalties.

Penalties and rules you need to know

The 10% early withdrawal penalty applies if you take money out before 59½, with a few exceptions. You can withdraw without penalty for a first-time home purchase (up to $10,000 lifetime), medical expenses that exceed 7.5% of your income, health insurance premiums while unemployed, or certain education costs. You can also withdraw contributions (not earnings) from a Roth IRA at any time. But if you take out earnings early from a Roth, or if you take out anything early from a Traditional IRA outside these exceptions, you pay the 10% penalty plus income tax.

A Traditional IRA requires you to start taking money out at age 73. The amount is calculated based on your age and account balance, and the IRS publishes tables to show you how much. If you do not take the full amount, you owe a 25% penalty on the shortfall (this was reduced from 50% in 2023). You can avoid this by converting to a Roth, but that triggers taxes on the conversion amount.

If you inherit an IRA from someone other than a spouse, the rules changed in 2020. You generally have to empty the account within 10 years, though you do not have to take money out every year—you just have to finish by year 10. Spouses who inherit an IRA can treat it as their own or roll it into their own IRA, which gives them more flexibility.

How to open an IRA and get your free guide

Opening an IRA takes about 15 minutes online. You choose a bank, brokerage, or credit union, fill out an application with your name, Social Security number, and address, and decide whether you want a Traditional or Roth. You then link a bank account to fund it. Most institutions let you set up automatic monthly contributions, which makes it easier to stick to your goal.

Before you open one, think about what type makes sense for your situation. If you want a tax deduction this year and expect lower income in retirement, a Traditional IRA is simpler. If you want tax-free withdrawals later and do not need a deduction now, a Roth is worth considering. If your income is too high for a Roth, look into a backdoor Roth or stick with a Traditional IRA.

Once the account is open, you decide what to invest in. If you are not sure, many brokerages offer target-date funds—funds that automatically shift from stocks to bonds as you get closer to retirement. These are a reasonable starting point if you do not want to pick individual investments.

Frequently Asked Questions

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

Yes. Your combined contributions to both cannot exceed the annual limit ($7,000 for 2024), but you can split the money between them however you want. Some people use a Traditional IRA for the tax deduction and a Roth for tax-free growth, depending on their income and goals.

What happens if I do not use my IRA for retirement?

You can leave the money in the account as long as you want (except for required withdrawals from a Traditional IRA starting at 73). If you need it before retirement, you can withdraw it, but you will owe taxes and possibly a 10% penalty unless you meet one of the exceptions.

Can I contribute to an IRA if I do not have a job?

No, you must have earned income to contribute. If you are self-employed or a freelancer, your business income counts. If you have no income, you cannot contribute, but a spouse with income can open a spousal IRA in your name if you file taxes jointly.

What is the difference between rolling over a 401(k) and converting it to an IRA?

A rollover moves money from a 401(k) into an IRA without triggering taxes, as long as it goes directly from one institution to the other. A conversion moves money from a Traditional IRA (or 401(k)) into a Roth IRA, and you pay income tax on the amount converted in that year.

Do I pay taxes on IRA earnings every year?

No. In a Traditional IRA, you do not pay taxes on earnings until you withdraw. In a Roth IRA, you never pay taxes on earnings. This tax shelter is what makes IRAs powerful for long-term growth.