Individual Retirement Accounts (IRA) 101
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Regular savings accounts are fine for storing short-term savings, but if you’re saving for retirement, an Individual Retirement Account (IRA) is better.
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What is an IRA?
An Individual Retirement Account (IRA) is an account designed for building retirement savings. Unlike an ordinary bank savings account, it allows you to purchase investments, such as mutual funds and stocks, and offers tax breaks that can save you thousands of dollars over the life of the account.
Both of the primary varieties of IRAs — the traditional IRA and the Roth IRA — allow you to save $5,500 per year ($6,500 if you’re 50 or older), even if you’re also contributing to a 401(k) or other workplace savings plan. (Note: For tax year 2019, the IRS has increased this limit to $6,000 for younger savers and $7,000 for those 50 and older.)
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 IRA, contributions are not tax-deductible, but unlike with a traditional IRA, you can withdraw money tax-free in retirement from a Roth.
Average savings account interest rates have languished well below 1% for more than a decade, but you’ll find many of the investments available through IRAs have earned far higher returns over the long term. (Don’t worry if you’re new to this realm. See how to invest your IRA for some simple and effective investment strategies.)
How to choose the right type of IRA
First things first: Not everyone is eligible for all the perks of traditional and Roth IRAs.
Your income level will determine whether you’re allowed to contribute to a Roth IRA. Anyone — regardless of income — can contribute to a traditional IRA. But the amount of your traditional IRA contribution that you’re allowed to deduct from your taxes may be limited by your income and whether you or your spouse has access to a retirement plan at work. See this year’s thresholds below or view the full list of income and eligibility requirements.
If you’re eager to get a tax break today versus one in retirement, a traditional IRA may be a good choice since the money you contribute may be deductible from your taxes for the year.
What’s the advantage? Perhaps you’re subject to a high tax bracket today and expect to be in a lower tax rate in retirement. Or maybe the upfront tax break is what attracted you to IRAs in the first place.
Keep in mind that when it comes to withdrawals, you will either need to be age 59 ½ or meet some specific requirements to take money from a traditional IRA without paying a penalty — 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.
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 will pay taxes on both your contributions and earnings when you withdraw money.)
On the withdrawal front, 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.
These aren’t the only differences between these account types, however. To get the full rundown, see traditional IRAs versus Roth IRAs.
Opening your IRA
Before choosing an IRA 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 top-ranked IRA account providers 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 for an IRA is pretty simple: Provide some general information (Social Security number, birthdate, contact information, employment details). Then choose how you want to fund the account — via bank transfer, perhaps rolling over a 401(k) from a previous employer.
For more details on getting started, see our guide to opening an IRA.