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 when you stop working. The government created IRAs to encourage people to save for retirement by offering tax breaks you would not get with a regular savings account. The money you put in, the money it earns, or both—depending on the type of IRA—may not be taxed until you withdraw it in retirement, or may never be taxed at all.

You can open an IRA at a bank, credit union, brokerage firm, or insurance company. You decide how much to put in each year (up to a limit set by the government), and you decide how to invest it—or you can keep it in cash. The account is yours alone; your employer does not run it, and you keep it even if you change jobs.

Key Takeaways

  • An IRA is a personal retirement savings account that offers tax advantages the government does not offer regular savings accounts.
  • The two main types are Traditional IRAs, where contributions may be tax-deductible now and withdrawals are taxed later, and Roth IRAs, where contributions are made with after-tax money but withdrawals in retirement are tax-free.
  • You can contribute up to $7,000 per year (or $8,000 if you are 50 or older), though you must have earned income to open one.
  • You cannot withdraw money penalty-free before age 59½ in most cases, which is the trade-off for the tax break.

Traditional IRA vs. Roth IRA: The main difference is when you pay taxes

A Traditional IRA lets you deduct your contributions from your taxes in the year you make them—if you meet income limits. The money grows without being taxed each year. When you withdraw it in retirement, you pay income tax on the full amount. This works well if you expect to be in a lower tax bracket after you retire.

A Roth IRA works the opposite way. You contribute money you have already paid taxes on, so you get no tax deduction now. But the money grows tax-free, and when you withdraw it in retirement, you owe no tax on any of it—not on what you put in, and not on what it earned. This works well if you expect to be in a higher tax bracket later, or if you straightforward want to lock in your current tax rate.

Both accounts have the same yearly contribution limit and the same age rules for penalty-free withdrawal. The choice between them depends on whether you want a tax break now (Traditional) or tax-free withdrawals later (Roth). Many people open both and split their contributions.

How much you can contribute each year

For 2024, you can put up to $7,000 per year into an IRA—either a Traditional, a Roth, or split between them. If you are 50 or older, you can contribute an extra $1,000 per year, for a total of $8,000. These limits reset each January 1st.

You must have earned income to open an IRA and to contribute. Earned income means wages from a job, self-employment income, or other money you received for work. Money from investments, pensions, or Social Security does not count. If you have a spouse with earned income and you do not, some rules let you contribute based on their income instead.

You can contribute at any time during the year, but the important date to contribute for a given tax year is usually April 15th of the following year (the same day your taxes are due). If you miss that important date, you cannot go back and contribute for that year.

When you can withdraw money without a penalty

The main rule is that you cannot withdraw money from an IRA penalty-free before age 59½. If you do, the IRS charges you a 10 percent penalty on top of the income tax you owe on the withdrawal. This penalty exists because the whole point of an IRA is to save for retirement, not to use it as an emergency fund.

There are narrow exceptions. With a Traditional IRA, you can withdraw penalty-free (though you still owe income tax) if you are disabled, if you are paying medical expenses that exceed a certain percentage of your income, or if you are paying health insurance premiums while unemployed. With a Roth IRA, you can always withdraw the money you contributed (not the earnings) without penalty, because you already paid taxes on it.

Once you turn 59½, you can withdraw as much as you want, whenever you want, with no penalty. You will owe income tax on Traditional IRA withdrawals, but not on Roth withdrawals (as long as the account has been open for at least five years).

Required withdrawals in later retirement

With a Traditional IRA, the government eventually requires you to start taking money out. These are called Required Minimum Distributions (RMDs). They begin the year after you turn 73 (as of 2023; this age has been rising). The IRS calculates the minimum amount you must withdraw each year based on your age and account balance, and you owe income tax on it.

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, and your heirs inherit it tax-free. This makes Roths useful if you do not need the money in retirement and want to pass wealth to the next generation.

How to open an IRA and where to open it

You can open an IRA at almost any financial institution: a bank, credit union, brokerage firm like Fidelity or Vanguard, or an insurance company. Each offers different investment options. Banks typically offer IRAs that hold savings accounts or certificates of deposit (CDs). Brokerages offer IRAs where you can buy stocks, bonds, mutual funds, or exchange-traded funds (ETFs). Insurance companies offer IRAs tied to annuities.

To open an account, you will need to provide your name, Social Security number, date of birth, and address. The institution will ask whether you want a Traditional or Roth IRA. You can then decide how much to contribute and how to invest it. Some institutions have minimum opening balances; others do not.

You can open as many IRAs as you want, but your total contributions across all of them cannot exceed the yearly limit. If you have an IRA at one institution and want to move it to another, you can do a rollover (the institution transfers it directly) or a transfer (you move the money yourself within 60 days). Both keep the account tax-deferred.

IRAs vs. employer retirement plans

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

Employer plans often come with matching contributions—your employer adds money if you contribute. That is information programs, so most financial advisors recommend contributing enough to get the full match before maxing out an IRA. IRAs offer more investment choices and lower fees in many cases, so after you get the match, an IRA may be the better place to save more.

If you are self-employed or own a small business, you cannot use a regular 401(k), but you have other options like a SEP IRA or Solo 401(k) that let you save more than the standard IRA limit.

Frequently Asked Questions

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

Yes. You can split your yearly contribution between them however you want, as long as the total does not exceed $7,000 (or $8,000 if you are 50 or older). Many people use both: a Traditional IRA for the when ready tax deduction and a Roth for tax-free growth later.

What happens to my IRA if I die?

Your IRA passes to whoever you named as the beneficiary on the account. They can inherit it as a lump sum, take it out over time, or in some cases roll it into their own IRA. The rules vary by account type and beneficiary relationship, so name a beneficiary and review it every few years.

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

First-time homebuyers can withdraw up to $35,000 from a Roth IRA (lifetime limit) without the 10 percent early withdrawal penalty, though you still owe income tax on earnings. Traditional IRAs do not have this exception. Check with the IRA provider about the exact rules and timing.

What if I earn too much money to open a Roth IRA?

Roth IRAs have income limits that change each year. If your income is too high, you cannot contribute directly. However, you can use a strategy called a "backdoor Roth" to convert a Traditional IRA into a Roth, though this has tax and income-limit complications. Speak with a tax professional if this applies to you.

Do I need to report my IRA on my taxes?

You report IRA contributions and withdrawals on your tax return. Your IRA provider sends you a form (1099-R for withdrawals, or a statement for contributions) that you use when filing. If you take an early withdrawal with a penalty, the IRS knows about it and will charge you unless you claim an exception.