What is an IRA?
An Individual Retirement Account (IRA) is an investment account designed for building retirement savings. There are several types — traditional IRAs, Roth IRAs, SEP IRAs, SIMPLE IRAs and more — and all offer tax benefits that reward you for saving. Generally, you (or your spouse) need to have earned income to contribute to an IRA.
How an IRA works
Two of the most popular types of accounts — the traditional IRA and the Roth IRA — allow you to save $6,000 per year ($7,000 if you’re 50 or older), even if you’re also contributing to a 401(k) or other workplace savings plan. (Those limits are up from $5,500 and $6,500 in 2018.)
With a traditional IRA, contributions are tax-deductible up to IRS limits, and you won’t owe income taxes until you withdraw the funds. With a Roth, contributions are not tax-deductible, but your investments grow tax-free and you can withdraw money tax-free in retirement from a Roth.
Most banks and brokers offer traditional and Roth accounts, but the types of investments you’ll have access to will vary depending on the provider. With a bank, you’ll likely find certificates of deposit. With a broker, you’ll be able to invest in stocks and bonds. For a long-term goal like retirement, we generally recommend stocks and bonds because of their higher returns. (See how to invest your IRA for simple investment tips.)
There are other types of IRAs, too, with a variety of benefits in different situations, including spousal IRAs, self-directed IRAs, SEP IRAs, SIMPLE IRAs, backdoor Roths and inherited IRAs. See more about each of these below.
» Ready to get started? These are our top picks for the best IRA accounts
With a traditional IRA, generally you can deduct the amount of your contributions on your tax return, and your money grows tax-deferred — that is, you won’t owe income taxes until you withdraw the money from your account.
Anyone — regardless of income — can contribute to a traditional account. But the amount of your contribution that you’re allowed to deduct from your taxes may be limited by your income if you or your spouse has access to a retirement plan at work.
If you (or your spouse) has a retirement plan at work, then check out the deduction limits:
If you’re eager to get an upfront tax break today, a traditional IRA may be a good choice. Or, if you expect to pay a lower tax rate in retirement, then delaying the tax bill until then makes sense.
Keep in mind that to avoid a withdrawal penalty when taking money out of a traditional IRA, you'll need to be age 59 ½ or meet some specific requirements — see traditional IRA withdrawals for details.
If you’ve got the willpower to wait to get your tax break, the Roth can be an especially attractive option.
With a Roth, contributions are not tax-deductible, but your money grows tax-free — you never owe taxes on the investment gains in your account — and you can withdraw money tax-free in retirement.
While you can’t deduct Roth contributions from your taxable income while you’re saving, in retirement your Roth withdrawals are not taxed at all. That goes for contributions and investment earnings. (With a traditional IRA, you pay taxes on both your contributions and earnings when you withdraw money.)
The Roth comes with another big perk: You can take out money you contributed to a Roth IRA at any time without penalty. But there are rules about early withdrawals of investment earnings and other transferred funds — see Roth IRA withdrawals for details.
There are income limits that prevent higher earners from contributing to Roths. (However, in that situation, a backdoor Roth IRA is another option — more on that below.) Here are the latest Roth contribution limits:
Backdoor Roth IRA
If your income priced you out of making Roth IRA contributions, fear not. You can still open a Roth, thanks to the backdoor Roth IRA option. (The name “backdoor Roth” is not an official account name; it describes a tax strategy.)
Put simply, you open a traditional IRA and then convert it to a Roth. Ideally, your traditional IRA accounts — the one you want to convert plus other traditional IRAs you might have — consist entirely of nondeductible contributions. If not, be prepared for a tax bill. The IRS’s pro-rata rule means that if you have traditional IRA contributions for which you’ve taken a tax deduction, even if those contributions are in another traditional IRA account, some portion of the money you convert to the Roth IRA likely will be taxable. Read more about backdoor Roth IRAs.
Generally, to contribute to an IRA, you need to have earned income. A spousal IRA is one exception to that rule: these accounts let spouses who don’t work for pay contribute to either a traditional IRA or a Roth IRA, based on their working spouse’s income.
The spousal IRA is owned by the non-working spouse, and the maximum contribution is $6,000 ($7,000 if 50 or older). But there’s another limit: the total contributions of both spouses to each of their IRAs can’t exceed the working spouse’s earned income. Read more about spousal IRAs.
Technically, almost all IRAs are self-directed, in that you choose your own investments for the account. But “self-directed” has come to describe a special type of IRA: one that lets you invest in alternative investments, such as real estate or a privately-held company. You’ll need to find a custodian who’s willing to let you do that — the brokers that are household names generally don’t offer self-directed IRAs.
Self-directed IRAs can come in the traditional or Roth flavor, and they have the same income and eligibility rules. The only difference is the type of investments you own in the account. Read more about self-directed IRAs.
SEP stands for “simplified employee pension.” These accounts are a useful retirement savings tool for small-business owners and self-employed people. Like a traditional IRA, a SEP IRA offers a tax deduction on contributions. Your savings grow tax-deferred, and withdrawals in retirement are taxed at regular income tax rates. If you have eligible employees, the IRS requires you to contribute to their accounts at the same rate that you contribute to your account. For example, if you’re saving 10% of your compensation, then you must contribute the same percentage of employees’ compensation to their accounts. Employees generally can’t contribute to a SEP IRA (though some SEP IRAs allow for traditional IRA contributions).
The big appeal of these accounts for business owners is that the maximum contribution is $56,000 in 2019, much higher than the $6,000 max for traditional IRAs. One caveat: You can’t contribute more than 25% of compensation. Read more about SEP IRAs.
SIMPLE IRAs are retirement savings vehicles for small companies, generally with 100 or fewer employees. Compared with a 401(k), a SIMPLE IRA is relatively easy for employers to set up. (SIMPLE stands for Savings Incentive Match Plan for Employees.)
Employers are required to contribute to the plan, based on specific IRS rules. And, unlike a SEP IRA, with a SIMPLE IRA employees can contribute their own money, up to $13,000 a year, plus an extra $3,000 catch-up contribution for people 50 and older. The amount employees contribute will reduce their taxable income for the year, and their money will grow tax-deferred until they withdraw it in retirement, at which point income taxes apply on withdrawals. Read more about SIMPLE IRAs.
An inherited IRA, also known as a beneficiary IRA, comes with some very specific rules — and you want to follow them so you avoid a big tax bill. Keep in mind that the rules vary depending on your relationship with the deceased person. Read more about inherited IRAs.
Opening your IRA account
Before choosing a provider, ask yourself how involved you want to be in the management of your investments:
If you want to choose investments for yourself, an online brokerage is a good way to go. Review our best IRA accounts to compare.
If you want help managing your retirement account, consider a robo-advisor — a service that selects low-cost and risk-appropriate investments for you. See our list of best robo-advisors for help choosing the right one for you.
Once you have chosen a provider, the online signup process is pretty simple: You'll be asked to provide some general information, including Social Security number, birthdate, contact information and employment details. See our guide to opening an IRA for more information on moving money into your account.