Individual Retirement Account: Definition, 5 Types

An individual retirement account (IRA) is a tax-advantaged investment account that helps you save for retirement. Money can grow tax-free or tax-deferred, depending on the type of IRA.
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What is an IRA?

An individual retirement account (IRA) is a tax-advantaged investment account that helps you save for retirement. Money invested in an IRA grows either tax-free or tax-deferred, depending on the type of account you have.

Anyone earning an income is eligible to open a traditional IRA — including people with a 401(k) account through work, a nonworking spouse whose partner is earning an income, or even a minor making their own money.

An IRA can be opened through a bank, broker or robo-advisor.

» Ready to get started? Review our best IRA accounts to compare.

How does an IRA work?

IRAs work by taking the money you put in, and investing it in stocks, bonds, exchange-traded funds or other assets.

The IRS sets annual limits, and you’re able to contribute up to the maximum. In 2024, you can contribute up to $7,000 a year to an IRA if you're under 50, or $8,000 if you're 50 or older

.

How your account balance grows over time depends on how much you contribute to the IRA and how you invest. (See how to invest your IRA for simple investment strategies.) There are several types of IRAs, including the traditional IRA and Roth IRA for individuals, and SEP IRA and SIMPLE IRA for business owners and self-employed individuals.

While you can have more than one type of IRA, the accounts have a single annual contribution limit. And because IRAs are intended to be used for retirement, there are also withdrawal rules: You may face a 10% penalty and a tax bill if you withdraw money from a traditional IRA before age 59½, unless you qualify for an exception

Internal Revenue Service. What If I Withdraw Money From My IRA?. Accessed Jun 27, 2024.
.

» Are you on track for retirement? Use our retirement calculator to see.

IRA benefits

A big benefit of an IRA is that the money you invest grows either tax-free or tax-deferred.

  • If you contribute to a traditional IRA, you may get a tax deduction on your contributions in the year they are made; you'll then pay taxes when you take distributions in retirement.

  • If you contribute to a Roth IRA, you do not receive an immediate tax deduction or benefit, but your retirement distributions are tax-free.

But the tax advantages are not the only perk.

“The main benefit of an IRA is your ability to have more investment options and choices,” says certified financial planner Matt Aaron, founder of Washington, D.C.-based Lux Wealth Planning, an affiliate of Northwestern Mutual.

An employer-sponsored 401(k) may have limited investments or may not let you choose your own. And a 401(k) or pension alone may not provide enough money for you in retirement. Contributing to an IRA can offer you more access to investment options, increased retirement income and, yes, tax savings.

One downside of IRAs is that annual contributions are limited. You can contribute $23,000 to a 401(k) in 2024 and take advantage of an employer match if it’s offered. IRA contribution limits, on the other hand, are much lower.

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IRA contribution limits

In 2024, the maximum you can contribute among all your IRAs is $7,000 ($8,000 for those 50 or older). While you can have more than one IRA and contribute to all of them in a single year, the contribution limit is a combined limit

.

Traditional IRA contributions may also be tax-deductible, depending on how much you earn.

The income limits on traditional IRA deductions only apply if you (or your spouse) have a retirement plan at work.

Filing status

2024 traditional IRA income limit

Deduction limit

Single or head of household (and covered by retirement plan at work)

$77,000 or less.

Full deduction.

More than $77,000, but less than $87,000.

Partial deduction.

$87,000 or more.

No deduction.

Married filing jointly (and covered by retirement plan at work)

$123,000 or less.

Full deduction.

More than $123,000, but less than $143,000.

Partial deduction.

$143,000 or more.

No deduction.

Married filing jointly (spouse covered by retirement plan at work)

$230,000 or less.

Full deduction.

More than $230,000, but less than $240,000.

Partial deduction.

$240,000 or more.

No deduction.

Married filing separately (you or spouse covered by retirement plan at work)

Less than $10,000.

Partial deduction.

$10,000 or more.

No deduction.

5 types of IRAs

Here are five popular types of IRAs and an overview of each:

1. Traditional IRA

Contributions to traditional IRAs are often tax-deductible. For example, contributing $3,000 to a traditional IRA could reduce the amount of your taxable income by $3,000. However, withdrawals from traditional IRAs in retirement are taxable as ordinary income.

Generally, you can take penalty-free distributions from a traditional IRA starting at age 59½. If you take money out before then, you may have to pay a 10% penalty (there are some exceptions). You must start taking required minimum distributions when you reach a certain age, depending on the year you were born.

If you're married and you or your spouse has a retirement plan at work, the amount of your traditional IRA contribution that you can deduct is reduced and eventually eliminated once you hit a certain income. You can still make contributions, but they won’t be tax-deductible. If you and your spouse don't have retirement plans at work, then you can deduct your IRA contribution no matter how much your income is.

2. Roth IRA

Contributions to Roth IRAs aren't tax-deductible, but regular contributions (excluding Roth conversions) can be withdrawn penalty- and tax-free at any time. Additionally, there are no taxes on investment gains when taken out during retirement. It's an attractive option for investors who have a long time before they retire, says Aaron.

“The question is, do you want to pay your taxes now or later? For me, I’d rather pay taxes now,” says Aaron.

Roth IRAs can help you combat inflation, Aaron says, because money loses value over time. He says he thinks of a Roth IRA as paying taxes on the seed vs. paying taxes on the harvest.

"I don't have the magic ball and I can never say I know what’s going to happen in the future, but if taxes go up, and you’re taking that money out in the future, you get to potentially minimize the taxes you pay.”

There are income limits for Roth IRAs, so the amount you can contribute decreases and is eventually eliminated at certain incomes. If you earn too much to contribute to a Roth IRA, you can try the backdoor Roth method instead.

3. SEP IRA

Generally, SEP IRAs are for self-employed people or small business owners with few or no employees. Similar to traditional IRAs, the contributions are tax-deductible. Investments grow tax-deferred until retirement when distributions are taxed as income.

In 2023, contributions were limited to 25% of compensation or $66,000, whichever is less. If you applied for a tax extension by the April tax deadline, you can still contribute to your SEP IRA until Oct. 15, 2024

Internal Revenue Service. SEP Plan FAQs. Accessed Jun 7, 2024.
.

In 2024, contributions are limited to 25% of compensation or $69,000. There's no catch-up contribution at age 50 or older. SEP IRAs require proportional contributions for each eligible employee if business owners contribute for themselves

.

4. SIMPLE IRA

SIMPLE IRAs (Savings Incentive Match Plan for Employees Individual Retirement Accounts) are for small businesses with fewer than 100 employees. Similar to traditional IRAs, the contributions are tax-deductible. Investments grow tax-deferred until retirement, when distributions are taxed as income.

Employee contribution limits for a SIMPLE IRA in 2023 were $15,500 per year for those under age 50. People 50 and older could make an additional $3,500 catch-up contribution for 2023. For 2024, the contribution limit rises to $16,000. The catch-up contribution remains unchanged at $3,500

. Employer contributions are mandatory and can be made up until the tax filing deadline (including the extension deadline).

5. Rollover IRA

A rollover IRA isn’t exactly a type of IRA account, but a process in which you can transfer eligible assets from an employer-sponsored plan, such as a 401(k), into an IRA. People tend to do this when they're switching jobs so they can house all of their money in one place.

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How to open an IRA

Two popular ways to open an IRA are through brokers and robo-advisors. If you want to choose investments for yourself, an online broker can be a good way to go. If you want help managing your retirement account, consider a robo-advisor — a service that selects low-cost and risk-appropriate investments for you.

» Ready to get started? Read how to open an IRA for details.

Frequently asked questions

IRA stands for individual retirement arrangement. That’s the official name given by the IRS, but most people think of IRAs as individual retirement accounts, and that’s exactly what they are. While there are different types of IRAs, all of them are retirement accounts that offer tax benefits to encourage people to save for retirement. Almost all IRAs require you to have income from work.

Many discount brokers and robo-advisors have $0 minimums to open an IRA. However, the tax perks of investing in an IRA begin only once you've started contributing money to the account. The maximum the IRS allows you to contribute is up to $7,000 in 2024. You can contribute an extra $1,000 per year if you’re age 50 or over. You can contribute the full amount, but it is not required.

You can add money to your IRA at whatever cadence and amount works for your budget. Many brokers and robo-advisors allow investors to set up automatic deposits to transfer money from a bank into an account.

You can have both a 401(k) and an IRA. A 401(k) offers more opportunity to increase your retirement savings compared with an IRA. In 2024, the maximum contribution limit is $23,000 for a 401(k) compared with $7,000 for an IRA. If you’re 50 years or older, the catch-up contribution is larger as well, at $7,500 for the 401(k) versus $1,000 for the IRA.

You could consider investing primarily in an IRA if you don't get an employer match, if you plan to max out your 401(k), or if your 401(k) has narrow investment options or high fees.

Yes. You can put your IRA money in a variety of investments, and some of those investments may lose value.

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