What Is an Individual Retirement Account (IRA)?

An individual retirement account offers valuable tax benefits for retirement savers. Here's how IRAs work.

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What is an IRA?

An individual retirement account (IRA) is a tax-advantaged investment account for retirement available at banks, robo-advisors and brokers. There are four popular types of IRAs: traditional, Roth, SEP and SIMPLE. Contributions may be tax-deductible or withdrawals may be tax-free.

Understanding IRAs: 5 key facts

  1. You can open an IRA at a bank, robo-advisor or a broker. If you open an IRA at a broker or robo-advisor, you’ll be able to invest in stocks and bonds; IRAs from banks generally offer certificates of deposit and savings accounts. » Ready to get started? View our top picks for the best IRA accounts and where to get them

  2. You invest the money in the account. You can invest in stocks, bonds and other assets. How your account balance grows over time depends on how you invest and how much you contribute to the IRA. (See how to invest your IRA for simple investment strategies.)

  3. The common types of IRAs are traditional, Roth, SEP and SIMPLE.

  4. IRAs have annual contribution limits. Generally, you (or your spouse) must have earned income to contribute to an IRA.

  5. There are withdrawal rules. You may face a 10% penalty and a tax bill if you withdraw money before age 59 1/2, unless you qualify for an exception.

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What are the types of IRA?

There are four popular types of IRAs: traditional, Roth, SEP and SIMPLE. Here's an overview:

Traditional IRA

Contributions to traditional IRAs are often tax-deductible. For example, contributing $6,000 to a traditional IRA could reduce the amount of your taxable income by $6,000. However, withdrawals from traditional IRAs in retirement are taxable as ordinary income. The contribution limit for traditional IRAs in 2020 and 2021 is $6,000 per year. People 50 and older can contribute up to $7,000 per year.

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, or eliminated altogether, 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.

Traditional IRA deduction limits in 2020 and 2021

How much of your traditional IRA contributions can you deduct on your taxes? These income limits apply only if you (or your spouse) have a retirement plan at work.

Filing status

2020 MAGI

2021 MAGI

Deduction

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

$65,000 or less

$66,000 or less

Full deduction

More than $65,000 but less than $75,000

More than $66,000 but less than $76,000

Partial deduction

$75,000 or more

$76,000 or more

No deduction

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

$104,000 or less

$105,000 or less

Full deduction

More than $104,000 but less than $124,000

More than $105,000 but less than $125,000

Partial deduction

$124,000 or more

$125,000 or more

No deduction

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

$196,000 or less

$198,000 or less

Full deduction

More than $196,000 but less than $206,000

More than $198,000 but less than $208,000

Partial deduction

$206,000 or more

$208,000 or more

No deduction

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

Less than $10,000

Less than $10,000

Partial deduction

$10,000 or more

$10,000 or more

No deduction

Generally, you can take distributions from a traditional IRA starting at age 59 1/2. 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 age 70 1/2 or 72, depending on your birthday.

Roth IRA

Contributions to Roth IRAs are not tax-deductible, but withdrawals from Roth IRAs are tax-free and there are no taxes on investment gains. Roth IRAs do not have required minimum distributions. Also, you can contribute to a Roth IRA at any age as long as you have earned income. However, there are income limits on who can contribute to a Roth IRA.

In 2021 the contribution limit is $6,000 ($7,000 if 50 or older) for modified adjusted gross incomes below $140,000 (single filers) or $208,000 (married filing jointly). In 2020 the contribution limit was $6,000 ($7,000 if 50 or older) for modified adjusted gross incomes below $139,000 (single filers) or $206,000 (married filing jointly).

PayPal co-founder Peter Thiel recently made the news after a ProPublic report showed that he bought 1.7 million shares of company stock back in 1999 for just $1,700 -- and he did so in a Roth account. This kind of IRA an attractive option for investors who have a long time before they retire, financial advisors say.

Do you qualify for a Roth?

Filing status

2020 MAGI

2021 MAGI

Maximum annual contribution

Single, head of household or married filing separately (if you didn't live with spouse during year)

Less than $124,000

Less than $125,000

$6,000 ($7,000 if 50 or older)

$124,000 up to $139,000

$125,000 up to $140,000

Contribution is reduced

$139,000 or more

$140,000 or more

No contribution allowed

Married filing jointly or qualifying widow(er)

Less than $196,000

Less than $198,000

$6,000 ($7,000 if 50 or older)

$196,000 up to $206,000

$198,000 up to $208,000

Contribution is reduced

$206,000 or more

$208,000 or more

No contribution allowed

Married filing separately (if you lived with spouse at any time during year)

Less than $10,000

Less than $10,000

Contribution is reduced

$10,000 or more

$10,000 or more

No contribution allowed

SEP IRA

Generally, SEP IRAs are IRAs 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 2021, contributions are limited to 25% of compensation or $58,000, whichever is less. In 2020 the limit was 25% of compensation or $57,000. There's no catch-up contribution at age 50+ for SEP IRAs, and SEP IRAs require minimum distributions beginning at age 72. SEP IRAs require proportional contributions for each eligible employee if business owners contribute for themselves.

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 2020 and 2021 are $13,500 per year for those under age 50. People age 50 and older can make an additional $3,000 catch-up contribution. Employer contributions are mandatory.

What is the benefit of an IRA?

401(k) or pension may not provide enough retirement income. Putting money in an IRA can help you prepare for retirement, save on taxes and access investment options your workplace retirement plan might not offer. Your savings may grow faster in an IRA than in a taxable account.

The benefits of an IRA and Roth IRA

IRA vs. 401(k): Can I have both?

Yes. Both 401(k)s and IRAs have valuable tax benefits, and you can contribute to both at the same time. The big difference between them is that employers offer 401(k)s, while individuals open IRAs (through banks or brokers). IRAs typically offer more investments; 401(k)s allow higher annual contributions.

IRAs make a great supplement to retirement savings in addition to a 401(k) if you’re contributing enough to receive a full match from your employer, or you’re planning on maxing out your 401(k). If you don’t receive a match on your 401(k) or it has narrow investment options or high fees, it may be a good idea to invest primarily in an IRA.

If you have an old 401(k), you can also move that money into a rollover IRA. A benefit of a rollover IRA is that when done correctly, the money keeps its tax-deferred status and doesn't trigger taxes or early withdrawal penalties.

How to open an IRA

Two popular ways to get an IRA are through brokers and robo-advisors.

  • Brokers: If you want to choose investments for yourself, an online broker can be a good way to go. Review our best IRA accounts to compare.

  • Robo-advisors: 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.

See our guide to opening an IRA for more information on moving money into your account.

Frequently asked questions

Both IRAs and 401(k)s are retirement savings accounts, and both offer tax breaks as an incentive to sock away money for your future. But 401(k)s are available only through an employer (in technical IRS language, they're employer-sponsored retirement plans) while an IRA can be set up by any individual who has earned income.

Other noteworthy differences:

  • 401(k)s have higher annual contribution limits than IRAs: $19,500 in 2020 versus $6,000 in an IRA.

  • Catch-up contribution limits are beefier in workplace plans: If you’re age 50 or older, the IRS allows you to save an additional $6,500 in 2020 and 2021 in a 401(k). The maximum annual catch-up contribution allowed in an IRA is $1,000.

  • You have until the tax filing deadline of the following year to make contributions to an IRA. Contributions to a 401(k) must be made by Dec. 31 in order to qualify for the current tax year.

  • Some 401(k)s have a vesting period where employees have to wait a certain period of time before they’re allowed to participate in the plan. There’s no vesting period with an IRA.

  • Some employers sweeten the pot with 401(k)s and kick in their own money to match a portion of what employees save. That extra money may be subject to a vesting period.

  • Investment offerings in a 401(k) are determined by the plan administrator. In an IRA the choices are much broader: If you choose to open an account at a discount brokerage you can pick from mutual funds, exchange-traded funds (ETFs), stocks and more.

If you’re wondering if it’s better to have a 401(k) or an IRA, here’s some good news: You don’t have to choose. The IRS allows savers to contribute to both an IRA and a 401(k) at the same time. And if you leave your company, you can take the money with you and roll it over into an IRA. (Here’s how to do a rollover IRA.)

Our advice: If your 401(k) offers an employer match, invest enough to get the full match. After that, direct your retirement savings dollars into a Roth or traditional IRA to take advantage of the more expansive line-up of investments.

Here’s a more detailed take on the IRA vs. 401(k) question, including a simple plan for how to maximize your returns and minimize your costs.

Many discount brokers and robo-advisors have $0 minimums to open an IRA. You can see which ones in our roundup of best IRA providers. However, the tax perks of investing in an IRA start only when you start contributing money to the account. But don’t worry: You don’t need to come up with your full contribution all at once. You’re also not required to save the maximum the IRS allows (up to $6,000 in 2021, or $7,000 if you’re age 50 or over).

You can add money to your IRA at whatever cadence and amount work for your budget. Many brokers and robos allow savers to set up automatic deposits to transfer money from your bank into your account.

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

Here’s how to move your retirement savings to another account. Learn more.

Information for spouses and non-spousal beneficiaries. Learn more.

When you can take withdrawals from your IRA, how much and the potential tax implications. Learn more.

You might qualify for a tax credit of up to $1,000 for contributing to your IRA. Learn more.

Spouses who don’t work for compensation can still contribute to IRAs. Learn more.

Self-directed IRAs (SDIRAs) can hold a variety of alternative investments. Learn more.

A backdoor Roth IRA offers a way to contribute to a Roth IRA even if your income is over the limit for Roth IRA contributions. Learn more.

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