An IRA is a tax-sheltered container for retirement savings that you control yourself

An Individual Retirement Account (IRA) is a bank or investment account with special tax rules attached. You put money in, that money grows over time through interest or investment returns, and you withdraw it in retirement. The tax benefit is the point: depending on which type of IRA you open, you either pay no tax on the growth, or you pay no tax when you withdraw the money later. The catch is that the IRS sets rules about when you can take the money out without penalty.

You open an IRA yourself at a bank, credit union, or brokerage firm—not through your employer, and not through a government office. The institution holds the account and keeps the records. You decide how much to put in each year (up to a limit set by the IRS), and you decide what happens to that money once it is inside the account. That last part matters: an IRA is not a specific investment. It is a wrapper around whatever investments you choose to hold.

The IRS allows you to open an IRA if you have earned income from work in that year. You cannot open one if you are retired and living only on Social Security or investment returns. The contribution limits change yearly—the IRS publishes them each October for the following year.

Key Takeaways

  • An IRA is a tax-sheltered savings account you open yourself at a bank or brokerage, not through an employer or government program.
  • The two main types are Traditional IRAs (you deduct contributions now, pay tax on withdrawals later) and Roth IRAs (you pay tax now, withdraw tax-free later).
  • Money inside an IRA can sit in a savings account, be invested in stocks or bonds, or held in other investments—you choose what goes in the account.
  • You cannot withdraw money before age 59½ without paying a 10 percent penalty, with narrow exceptions for hardship, first-time home purchase, or education costs.
  • At age 73, the IRS requires you to start taking withdrawals from Traditional IRAs, but Roth IRAs have no withdrawal requirement during your lifetime.

Traditional IRA versus Roth IRA: the tax timing difference

The two main types of IRA differ in when you pay income tax. With a Traditional IRA, you deduct your contribution from your taxable income in the year you make it—so if you earn $60,000 and contribute $7,000 to a Traditional IRA, you report only $53,000 as taxable income that year. The money grows tax-free inside the account. When you withdraw it in retirement, you pay ordinary income tax on the full amount you take out.

With a Roth IRA, you contribute money that you have already paid income tax on. You get no deduction now. But the money grows tax-free inside the account, and when you withdraw it in retirement, you owe no tax at all—not on the growth, not on the original contributions. The trade-off is that you pay tax upfront instead of later.

Which one makes sense depends on whether you think your tax rate will be higher or lower in retirement than it is now. If you are young and expect to earn more later, a Roth lets you lock in today's lower tax rate. If you are near retirement and expect to be in a lower tax bracket, a Traditional IRA saves you tax now when your rate is high. There is no objectively correct answer—it depends on your specific situation.

The IRS limits who can contribute to a Roth based on income. If you earn above a certain threshold (which changes yearly), you cannot contribute directly to a Roth IRA, though you may have other options. Traditional IRAs have no income limit, but if you are covered by a workplace retirement plan like a 401(k), the deduction phases out at higher incomes.

How money moves into and out of an IRA account

You fund an IRA by transferring money from your bank account to the IRA account you opened. You can do this once a year, or in smaller amounts throughout the year—the total just cannot exceed the annual limit. The institution holding your IRA will send you a form (usually a 1099-R or similar) at tax time showing how much you contributed, so you can report it correctly on your tax return.

Money inside the account can sit in a savings account earning interest, or you can instruct the institution to invest it in stocks, bonds, mutual funds, or other securities. Some people keep their IRA as a straightforward savings account at a bank. Others use a brokerage account and buy and sell investments constantly. The account itself is just the container—the tax rules explore to whatever is inside it.

When you withdraw money, the institution reports the withdrawal to the IRS on a 1099-R form. If you are under 59½ and do not may have access to for an exception, the IRS assesses a 10 percent early withdrawal penalty on top of ordinary income tax. The exceptions are narrow: you can withdraw without penalty for a first-time home purchase (up to $10,000 lifetime), education expenses, medical bills above a threshold, or disability. A few other situations may have access to, but they are specific and the burden is on you to document them.

Required withdrawals and what happens if you do not take them

At age 73, the IRS requires you to start withdrawing money from a Traditional IRA. The amount is calculated based on your age and life expectancy—the IRS publishes a table each year. If you do not take the required amount, the IRS charges a penalty equal to 25 percent of the shortfall (reduced to 10 percent if you correct it within two years). This rule does not explore to Roth IRAs while you are alive, which is one reason some people prefer them.

The required withdrawal amount is called a Required Minimum Distribution (RMD). You must take it by December 31 each year, or the penalty applies. If you do not need the money, you still have to withdraw it and pay tax on it—the IRS does not allow you to leave money in a Traditional IRA indefinitely to avoid taxation.

If you inherit an IRA from someone else, different rules explore. You may be required to withdraw the entire balance within ten years, or to take annual distributions based on your own life expectancy. The rules changed in 2023 and vary depending on your relationship to the person who left you the account.

What you can and cannot hold inside an IRA

You can hold most common investments inside an IRA: stocks, bonds, mutual funds, exchange-traded funds (ETFs), and certificates of deposit (CDs). You can also hold real estate investment trusts (REITs) and some alternative investments. The account is just a container, and the tax rules explore regardless of what is inside.

There are a few things you cannot hold: collectibles like art, stamps, or coins (with narrow exceptions for certain precious metals), life insurance, or securities of companies you control. You also cannot use IRA money to buy property and then live in it yourself—that would be a prohibited transaction. If you violate these rules, the IRS can disqualify the entire account, meaning you lose the tax shelter and owe back taxes plus penalties.

You can move money between investments inside the same IRA without tax consequences. You can also transfer money from one IRA to another IRA at a different institution—this is called a rollover or transfer. If you do it correctly (the institutions handle it directly), there is no tax. If you take the money out yourself and deposit it elsewhere, you have 60 days to complete the deposit, or the IRS treats it as a withdrawal and taxes it.

IRAs versus employer retirement plans like 401(k)s

An IRA is different from a 401(k) or similar workplace plan. With a 401(k), your employer sets up the plan, you enroll through your employer, and your employer may contribute matching funds. With an IRA, you open it yourself and fund it yourself. An employer cannot set up an IRA for you, though some small employers offer a simplified version called a SEP-IRA or straightforward IRA for self-employed people or small business owners.

The contribution limits are different. For 2024, you can contribute up to $7,000 to an IRA (or $8,000 if you are 50 or older), but you can contribute up to $23,500 to a 401(k) (or $31,000 if you are 50 or older). If your employer offers a 401(k) with matching funds, that is usually the better deal—the match is information programs. But if you are self-employed or your employer does not offer a plan, an IRA is how you save for retirement with tax advantages.

You can have both an IRA and a 401(k) at the same time. The contribution limits are separate. However, if you have a 401(k) through your employer, your ability to deduct Traditional IRA contributions may be limited depending on your income.

How to open an IRA and what paperwork you need

To open an IRA, you choose an institution—a bank, credit union, or brokerage firm—and contact them to open an account. You will need to provide your name, Social Security number, address, and employment information. Most institutions let you open an account online in minutes. You then transfer money from your bank account to fund it.

You do not need any special government approval or paperwork beyond what the institution requires. The IRS does not issue you a license or certificate. The institution keeps the records and reports your contributions and withdrawals to the IRS on your behalf.

At tax time, you report your IRA contributions on your tax return (Form 1040) and claim the deduction if you are using a Traditional IRA. If you took any withdrawals, the institution will send you a 1099-R form showing the amount. Your tax software or tax preparer will guide you through reporting it correctly.

Frequently Asked Questions

Can I have more than one IRA?

Yes. You can open multiple IRAs at different institutions. However, the annual contribution limit applies to all your IRAs combined—if you have two Traditional IRAs and one Roth IRA, the total you can contribute across all three is still $7,000 per year (or $8,000 if you are 50 or older). The institutions do not coordinate with each other, so you have to track the total yourself.

What happens to my IRA if I die?

Your IRA passes to whoever you named as beneficiary on the account. They do not have to go through probate. However, they will owe income tax on withdrawals from a Traditional IRA, and the IRS requires them to withdraw the money within ten years (with some exceptions). A Roth IRA passes to beneficiaries tax-free, but they still must withdraw it within ten years.

Can I borrow money from my IRA?

You cannot borrow from an IRA the way you can from a 401(k). If you take money out, it is a withdrawal, and the early withdrawal penalty applies if you are under 59½. The only exception is a 60-day rollover: you can withdraw money and redeposit it within 60 days without penalty, but you can only do this once per year across all your IRAs.

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

If you exceed the annual limit, the excess is called an excess contribution. You can withdraw it before your tax important date (including extensions) without penalty, but you will owe tax on any earnings it generated. If you do not withdraw it, the IRS charges a 6 percent penalty each year the excess remains in the account.

Do I have to have earned income to contribute to an IRA?

Yes. You can only contribute up to the amount of earned income you had that year. If you earned $5,000 from a job, you can contribute up to $5,000 to an IRA, even if the annual limit is higher. If you are married and your spouse has no income, your spouse can contribute to a spousal IRA if you have enough earned income for both of you combined.