An IRA is a tax-sheltered container for retirement money, not a savings account in the traditional sense

An Individual Retirement Account (IRA) is a legal structure the IRS created to let you save money for retirement with tax advantages. It is not a savings account at a bank—it is a wrapper around whatever investments or cash you choose to hold inside it. You open an IRA at a bank, brokerage, credit union, or other financial institution, and that institution holds the money according to IRS rules. The tax benefit is the point: money you put in may reduce your taxable income this year, and the money inside grows without being taxed each year until you withdraw it in retirement.

There are two main types: a Traditional IRA and a Roth IRA. The difference is when you get the tax break and when you pay taxes on withdrawals. A Traditional IRA gives you a tax deduction now; a Roth IRA taxes you now but lets withdrawals in retirement be tax-free. Which one makes sense depends on whether you expect to be in a higher or lower tax bracket when you retire.

Key Takeaways

  • An IRA is a tax-sheltered retirement account, not a savings account; the institution holding it can invest the money in stocks, bonds, mutual funds, or keep it as cash.
  • Traditional IRAs let you deduct contributions from your taxes now, but you pay income tax on withdrawals in retirement.
  • Roth IRAs tax you on contributions now, but withdrawals in retirement are tax-free, and you can withdraw contributions (not earnings) before retirement without penalty.
  • 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; the limit changes yearly.
  • You cannot withdraw earnings before age 59½ without paying income tax and a 10 percent penalty, except in narrow circumstances like a first home purchase or medical emergency.

How contributions and tax deductions work

When you put money into a Traditional IRA, you may deduct that contribution from your taxable income in the year you make it. If you earned $60,000 and contributed $7,000 to a Traditional IRA, your taxable income drops to $53,000. You pay income tax only on the $53,000. This deduction phases out if you earn above a certain threshold and also have a workplace retirement plan like a 401(k)—the IRS publishes the income limits each year, and they differ for single filers and married couples.

A Roth IRA works the opposite way. You contribute money that has already been taxed (you do not get a deduction), but the money grows tax-free inside the account, and you never pay tax on withdrawals in retirement. Roth contributions also have income limits: if you earn above a certain amount, you cannot contribute directly to a Roth. For 2024, the phase-out begins at $146,000 for single filers and $230,000 for married couples filing jointly, though these numbers change yearly.

You can contribute to an IRA only if you have earned income—wages, self-employment income, or taxable alimony. You cannot fund an IRA with investment returns, Social Security, or unemployment benefits. The annual contribution limit is the same for both Traditional and Roth: $7,000 for 2024 if you are under 50, or $8,000 if you are 50 or older. You can split this between a Traditional and a Roth, but the total across all your IRAs cannot exceed the limit.

What you can hold inside an IRA

An IRA is just a container. Inside it, you can hold stocks, bonds, mutual funds, exchange-traded funds (ETFs), certificates of deposit (CDs), or even cash sitting in a money market account. Some institutions offer self-directed IRAs, which let you invest in real estate, private loans, or other alternative assets, though these come with higher fees and more paperwork. Most people use a standard IRA at a bank or brokerage and invest in mutual funds or ETFs.

The institution holding your IRA—whether it is Vanguard, Fidelity, Charles Schwab, your local bank, or your credit union—does not decide what goes inside. You do. You can change your investments as often as you want without tax consequences. You can also move your entire IRA from one institution to another through a rollover or transfer, which takes a few days and does not trigger taxes or penalties if done correctly.

Withdrawal rules and early withdrawal penalties

The IRS wants you to leave money in an IRA until retirement. If you withdraw earnings before age 59½, you owe income tax on the withdrawal plus a 10 percent penalty. This applies to both Traditional and Roth IRAs, though the rules differ slightly.

With a Traditional IRA, you cannot withdraw anything before 59½ without the penalty, with narrow exceptions: a first-time home purchase (up to $10,000 lifetime), medical expenses that exceed 7.5 percent of your adjusted gross income, disability, or a series of substantially equal periodic payments. With a Roth IRA, you can withdraw your contributions (the money you put in) at any time without tax or penalty, because you already paid tax on that money. You can withdraw earnings only after age 59½ and only if the account has been open for at least five years.

Starting at age 73, the IRS requires you to take Required Minimum Distributions (RMDs) from Traditional IRAs each year. You calculate the amount based on your age and account balance, and the IRS publishes a table each year. If you do not take the full RMD, you owe a 25 percent penalty on the amount you should have withdrawn (this penalty was reduced from 50 percent in 2023). Roth IRAs have no RMD requirement during your lifetime, which is one reason some people prefer them.

Traditional IRA versus Roth IRA: which makes sense for you

Choose a Traditional IRA if you want to lower your taxable income now and expect to be in a lower tax bracket in retirement. This is common if you are still working and earning a high salary, or if you have self-employment income you want to reduce. The immediate tax deduction is the main appeal.

Choose a Roth IRA if you expect to be in a higher tax bracket in retirement, or if you simply want the certainty of tax-free withdrawals later. Roth IRAs are also better if you do not need the money in retirement and want to leave it to heirs tax-free, or if you want the flexibility to withdraw contributions early without penalty. Younger workers often benefit from Roth because they have decades for the money to grow tax-free and are likely in a lower tax bracket now than they will be later.

You can have both a Traditional and a Roth IRA at the same time, but your total contributions across both cannot exceed the annual limit. Some people use a strategy called a "backdoor Roth" to fund a Roth when their income is too high to contribute directly, though this involves converting a Traditional IRA and requires careful tax planning.

How IRAs fit into your overall retirement plan

An IRA is one tool among several. If your employer offers a 401(k), 403(b), or similar workplace plan, you can contribute to both that plan and an IRA in the same year. Many employers match 401(k) contributions—meaning they add assistance programs to your account—so it often makes sense to contribute enough to get the full match before maxing out an IRA. An IRA has lower contribution limits ($7,000 to $8,000 per year) than a 401(k) ($23,500 for 2024), so if you have the income and want to save more, a workplace plan lets you do that.

If you are self-employed or own a small business, you have other options: a SEP IRA (Simplified Employee Pension) or a Solo 401(k) both allow much higher contributions than a standard IRA. A SEP IRA lets you contribute up to 25 percent of your net self-employment income, up to $69,000 in 2024. These are worth exploring if you have significant self-employment income.

Opening an IRA and getting started

Opening an IRA takes minutes. You can do it online at any bank, brokerage, or credit union. You will need your Social Security number, proof of identity, and a funding source (a bank account to transfer money from). Most institutions have no minimum balance to open, though some require a small initial deposit. Once the account is open, you can contribute up to the annual limit, and you can do so until the tax filing deadline the following year (usually April 15).

If you have an old 401(k) from a previous job, you can roll it into an IRA. This is called an IRA rollover. The money moves directly from the old plan to the new IRA, and if done correctly, no taxes are owed. You have 60 days to complete the rollover, though it is safer to ask the old plan to send the money directly to the new IRA rather than to you—this avoids the 60-day clock and potential withholding taxes.

Frequently Asked Questions

Can I have more than one IRA?

Yes, you can have multiple IRAs at different institutions. However, your total contributions across all Traditional IRAs and all Roth IRAs combined cannot exceed the annual limit ($7,000 or $8,000 in 2024). The IRS tracks this across all your accounts, so you must keep track yourself.

What happens to my IRA if I die?

Your IRA passes to your beneficiary—whoever you named on the account. They can inherit the money tax-free if it is a Roth, or they will owe income tax on withdrawals if it is a Traditional IRA. Naming a beneficiary is one of the most important steps when you open an account, and you should update it if your circumstances change.

Can I withdraw money from my IRA to buy a house?

With a Traditional IRA, you can withdraw up to $10,000 lifetime for a first-time home purchase without the 10 percent penalty, though you still owe income tax on the withdrawal. With a Roth IRA, you can withdraw your contributions anytime without tax or penalty. If you have not owned a home in the past two years, you may may have access to as a first-time buyer for this rule.

Do I have to report my IRA on my taxes?

If you contribute to a Traditional IRA and claim the deduction, yes—you report it on your tax return. If you contribute to a Roth, you do not need to report the contribution itself, but the institution will send you a Form 5498 for your records. When you withdraw money, the institution sends you a Form 1099-R, which you report on your tax return.

What if I do not have earned income but my spouse does?

You can open a spousal IRA using your spouse's earned income. This lets a non-working spouse contribute up to the annual limit as long as the working spouse has enough earned income to cover both contributions. This is useful for one-income households and lets both people build retirement savings.