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

An IRA stands for Individual Retirement Account. It is a bank or investment account you open in your own name, designed to hold money you are setting aside for retirement. The main reason to use one instead of a regular savings account is that the government gives you tax breaks on the money you put in or the money it earns — which means you keep more of what you save.

You do not have to be self-employed or work for a company with a retirement plan to open an IRA. You can open one at almost any bank, credit union, or investment firm. The account itself works like any other savings account: you deposit money, it sits there, and you can watch it grow. The difference is the rules about when you can take the money out and how the government taxes it.

Think of an IRA as a locked box the government helps you build. In exchange for agreeing not to touch the money until you are around 59½ years old, the government lets you either deduct what you put in from your taxes that year, or lets the money grow without being taxed on the earnings. Either way, you end up with more money in retirement than you would have in a regular account.

Key Takeaways

  • An IRA is a retirement savings account that gives you tax breaks, either when you deposit money or when it grows.
  • You can open an IRA at a bank, credit union, or investment firm, and you do not need an employer to sponsor one.
  • The two main types are a Traditional IRA (where you may deduct deposits from your taxes now) and a Roth IRA (where deposits are not deductible, but withdrawals in retirement are tax-free).
  • You generally cannot withdraw money before age 59½ without paying a penalty, which is why the account is designed for retirement rather than short-term savings.
  • How much you can deposit each year has a limit set by the government, and that limit changes from year to year.

Traditional IRA vs. Roth IRA: The two main types

There are two common types of IRA, and they work in opposite directions. In a Traditional IRA, you put money in before taxes are taken out of your paycheck. That means you can subtract what you deposit from your income when you file taxes that year, which lowers the taxes you owe. The money then grows without being taxed. When you withdraw it in retirement, you pay income tax on it then.

In a Roth IRA, you put money in after taxes have already been taken out. You do not get a tax break that year. But the money grows tax-free, and when you withdraw it in retirement, you do not pay any income tax on it. This is useful if you think you will be in a higher tax bracket in retirement, or if you straightforward want to know that your withdrawals will not be taxed.

The choice between the two depends on your situation now and what you expect in retirement. If you want to lower your taxes this year, a Traditional IRA makes sense. If you want to avoid taxes in retirement and you are young enough that your income may rise, a Roth IRA often makes more sense. You can also have both types at the same time, though your total deposits across all IRAs cannot exceed the annual limit.

How much you can deposit each year

The government sets a limit on how much you can put into an IRA in a single year. That limit changes every few years as the cost of living rises. The limit is the same whether you have a Traditional IRA, a Roth IRA, or both combined.

If you are under 50 years old, the limit is one amount. If you are 50 or older, you can deposit an additional catch-up amount. This catch-up provision exists because people who start saving for retirement later in life need a way to save more quickly.

You can deposit the money all at once or spread it throughout the year. Many people set up automatic monthly deposits so they do not have to think about it. If you deposit more than the limit in a single year, you will owe a penalty, so it is worth keeping track of what you have already put in if you have multiple accounts.

When you can withdraw money without a penalty

The basic rule is that you cannot withdraw money from an IRA before age 59½ without paying a 10 percent penalty on top of income taxes. This is why an IRA is not a good place to put money you might need in the next few years — it is designed to stay locked away until retirement.

There are some exceptions. You can withdraw money early without the penalty if you are disabled, if you are a first-time homebuyer (up to $10,000 lifetime), or if you have large medical expenses. You can also withdraw money to pay for education costs for yourself or a family member. These exceptions exist because Congress recognized that sometimes life happens before retirement.

The rules are different for Roth IRAs. Because you already paid taxes on the money you put in, you can withdraw your deposits (not the earnings) at any time without penalty. You can only withdraw the earnings penalty-free after 59½. This makes a Roth IRA slightly more flexible if you are worried you might need access to your money.

How the money grows inside an IRA

An IRA is just a container. What grows your money is what you put inside it. You can keep cash in an IRA, but most people invest the money in stocks, bonds, or mutual funds. The IRA itself does not pick investments for you — you decide what to buy.

Some people choose very conservative investments, like bonds or money market funds, because they are close to retirement and do not want to risk losing money. Younger people often choose stocks or stock mutual funds because they have time to recover if the market drops. The longer your money sits in the account, the more time it has to grow through compound interest — meaning your earnings make their own earnings.

The tax advantage of an IRA is that you do not pay taxes on the growth each year like you would in a regular investment account. In a regular account, if a stock goes up in value, you owe capital gains tax when you sell it. In an IRA, that growth is sheltered from taxes until you withdraw the money (or never, in the case of a Roth).

Required withdrawals in retirement

With a Traditional IRA, the government eventually requires you to start taking money out. These are called Required Minimum Distributions, or RMDs. They begin the year after you turn 73 (as of 2023; this age has been rising gradually). The government calculates how much you must withdraw based on your age and account balance, and you have to take it out whether you need the money or not. You will owe income tax on whatever you withdraw.

Roth IRAs do not have required withdrawals during your lifetime. You can leave the money in the account to grow as long as you live. This is one reason some people prefer Roths — it gives you more control over when and how much you withdraw.

If you do not take out the required amount, the penalty is steep: 25 percent of the amount you should have withdrawn (or 10 percent if you correct it within two years). It is worth setting a calendar reminder if you have a Traditional IRA and are approaching the age when withdrawals begin.

Opening an IRA and getting started

Opening an IRA is straightforward. You can walk into a bank or credit union and ask to open one, or you can do it online through a brokerage firm like Fidelity, Vanguard, or Charles Schwab. You will need to provide your Social Security number, proof of identity, and proof of address. The process usually takes less than an hour.

Once the account is open, you decide how much to deposit and what to invest it in. If you are not sure what investments to choose, many firms offer target-date funds — these are pre-built portfolios that automatically shift from stocks to bonds as you get closer to retirement. They are a good starting point if you do not want to pick individual investments.

You can also transfer money from another IRA or from a workplace retirement plan like a 401(k) into an IRA. This is called a rollover, and it lets you consolidate retirement savings in one place. The rules around rollovers are specific, so it is worth asking the firm receiving the money to walk you through the process.

Frequently Asked Questions

Can I have both a Traditional IRA and a Roth IRA at the same time?

Yes. Your annual deposit limit applies to the combined total across all IRAs you own, but you can split the money between them however you want. Some people use both to get the tax benefits of each type.

What happens to my IRA if I change jobs?

Your IRA is yours alone and does not depend on your job. You keep it open and can keep depositing to it as long as you have earned income. If your new job offers a 401(k), you can have both an IRA and a 401(k) at the same time.

Can I withdraw money from my Roth IRA if I need it before retirement?

You can withdraw the money you deposited (your contributions) anytime without penalty. You cannot withdraw the earnings without penalty until age 59½, except in specific situations like disability or first-time home purchase.

Do I need a lot of money to open an IRA?

No. Many banks and brokerages let you open an IRA with as little as $1 or $25. Some have no minimum at all. You can start small and add to it over time.

What if I do not have earned income — can I still open an IRA?

Generally, no. You need to have earned income (wages, salary, or self-employment income) to contribute to an IRA. If you are married and your spouse has earned income, you may be able to open a spousal IRA, but the rules vary.