What an IRA does and how the money moves

An IRA (Individual Retirement Account) is a savings account the government created to let you set aside money for retirement with tax advantages. You open it at a bank, credit union, or brokerage firm. You put money in. That money sits there and can grow through interest or investment returns. When you turn 59½, you can take the money out without penalty. The tax advantage—either a deduction when you contribute or tax-free growth while it sits—is what makes it different from a regular savings account.

The mechanics are straightforward: you deposit money into the account (either as a lump sum or through regular contributions), the institution holds it, and you decide what happens to it—whether it stays in cash, gets invested in stocks or bonds, or some mix. The account grows over time. At retirement age, you begin withdrawals. The IRS has rules about how much you can put in each year and when you must start taking money out, but the basic flow is deposit, grow, withdraw.

Key Takeaways

  • An IRA is a retirement savings account you open at a bank or brokerage where you deposit your own money and choose how it's invested.
  • The two main types—Traditional and Roth—differ in when you get the tax break: Traditional gives you a deduction now, Roth lets withdrawals be tax-free later.
  • You can contribute up to a set amount each year (the limit changes annually and depends on your age), and you cannot withdraw before 59½ without paying a penalty.
  • The money you contribute is yours to keep; the account is not a loan or a benefit program, and you control where it's invested.
  • At age 73, the IRS requires you to start taking withdrawals from a Traditional IRA, but Roth IRAs have no withdrawal requirement during your lifetime.

Traditional IRA versus Roth IRA: the tax timing difference

The two main IRA types work the same way mechanically—you deposit, the money grows, you withdraw—but they differ in when you get the tax advantage. A Traditional IRA lets you deduct your contribution from your income taxes in the year you make it. If you earn $60,000 and contribute $7,000 to a Traditional IRA, you report $53,000 in taxable income that year. The catch: when you withdraw the money in retirement, those withdrawals are taxed as ordinary income.

A Roth IRA works backward. You contribute money that has already been taxed (no deduction now), but when you withdraw in retirement, the money comes out tax-free. You also get tax-free growth on the earnings inside the account. The tradeoff is that you pay taxes on the contribution upfront rather than on the withdrawal later. Which one makes sense depends on whether you expect to be in a higher or lower tax bracket in retirement—a question most people cannot answer with certainty, which is why many people use both.

There are income limits for Roth contributions (if you earn above a certain amount, you cannot contribute directly), but Traditional IRAs have no income limit. However, if you have a workplace retirement plan like a 401(k), the deduction for a Traditional IRA phases out at higher incomes. These rules change yearly, so the specific numbers vary.

How much you can contribute each year

The IRS sets an annual contribution limit—the maximum amount you can put into an IRA in a single year. That limit changes most years and is higher if you are 50 or older (the "catch-up" contribution). For example, in recent years the limit has been $6,500 for people under 50 and $7,500 for people 50 and older, but these numbers shift annually based on inflation.

You can contribute to both a Traditional and a Roth IRA in the same year, but your combined contributions cannot exceed the annual limit. If you contribute $4,000 to a Traditional IRA, you can only add $2,500 more to a Roth that year if the limit is $6,500. You do not have to contribute the maximum—you can put in any amount up to the limit, or nothing at all in a given year. Unused contribution room does not roll forward; if you do not use it, you lose it.

The contribution limit applies only to money you earn from work. If you are retired or have no income, you cannot contribute to an IRA that year. If you are married and one spouse has no income, that spouse can still contribute through a "spousal IRA" as long as the working spouse has enough earned income to cover both contributions.

When you can withdraw and what happens if you withdraw early

You can withdraw money from an IRA anytime, but the IRS penalizes early withdrawals. If you take money out before age 59½, you typically owe a 10 percent penalty on top of income taxes on the withdrawal. A $10,000 early withdrawal might cost you $1,000 in penalty plus whatever income tax you owe on that $10,000 depending on your tax bracket.

There are narrow exceptions. You can withdraw without penalty for a first home purchase (up to $10,000 lifetime), to pay for education expenses, for medical bills that exceed a percentage of your income, or if you become disabled. You can also withdraw contributions (not earnings) from a Roth IRA anytime penalty-free, since you already paid tax on that money. But for a Traditional IRA, all withdrawals are treated as taxable income, and the 10 percent penalty applies to early withdrawals unless an exception fits.

Once you reach 59½, you can withdraw as much or as little as you want, whenever you want, with no penalty. You will still owe income tax on Traditional IRA withdrawals, but the penalty disappears. Roth withdrawals of earnings are tax-free if the account has been open at least five years.

Required withdrawals in retirement

At age 73, the IRS requires you to start taking withdrawals from a Traditional IRA. These are called Required Minimum Distributions (RMDs). The IRS calculates the minimum amount based on your age and account balance, and you must withdraw at least that amount each year or face a penalty. The penalty for missing an RMD is steep—25 percent of the amount you should have withdrawn (reduced to 10 percent if you correct it within two years).

Roth IRAs have no RMD requirement during your lifetime, which is one reason some people prefer them—the money can keep growing tax-free without forced withdrawals. However, beneficiaries who inherit a Roth IRA do have withdrawal requirements, though the rules are complex and depend on when the original owner died.

If you are still working at 73 and do not own more than 5 percent of the company you work for, you may be able to delay RMDs from a workplace 401(k) until you actually retire, but IRAs have no such exception. The RMD age has shifted over time (it was 70½ for many years, then moved to 72, then to 73), so if you are near retirement, check the current rule.

Where to open an IRA and what institutions offer them

You can open an IRA at a bank, credit union, or brokerage firm. Banks and credit unions typically offer IRAs that hold cash or CDs (certificates of deposit), which earn a fixed interest rate. Brokerages offer IRAs where you can invest in stocks, bonds, mutual funds, or exchange-traded funds (ETFs). Some institutions offer both options.

The institution does not contribute money to your account—you do. They simply hold the account, process your deposits and withdrawals, and handle the tax reporting (they send you a Form 1099-R when you withdraw, for example). You can move money between institutions through a process called a rollover or transfer. A rollover means the old institution sends you a check, and you deposit it into the new institution within 60 days. A transfer means the institutions move the money directly without you touching it, which is simpler and avoids the 60-day deadline.

You can also convert a Traditional IRA to a Roth IRA, though you will owe income tax on the conversion in the year it happens. This is called a Roth conversion and is sometimes used as a tax strategy, but it is not required and comes with tax consequences you should understand before doing it.

How investment choices affect your IRA growth

If your IRA holds only cash or a CD, it grows slowly through interest—typically 4 to 5 percent annually in recent years, though rates change. If you invest in stocks or stock mutual funds, the growth potential is higher but so is the risk; you could lose money in a down market. Most people hold a mix—some stocks for growth, some bonds or cash for stability.

The IRA itself does not pick investments for you. You choose. If you open an IRA at a brokerage and do nothing, your money might sit in a money market account earning minimal interest. You have to actively decide to buy stocks, funds, or other investments. Some brokerages offer "target-date funds" that automatically adjust from stocks to bonds as you approach retirement, which removes the need to rebalance yourself.

One advantage of an IRA is that you can buy and sell investments inside it without triggering capital gains taxes. If you own a stock in a regular taxable account and sell it for a profit, you owe tax on the gain. Inside an IRA, you can trade freely without tax consequences until you withdraw. This is one reason IRAs are useful for active investors.

Frequently Asked Questions

Can I have more than one IRA?

Yes. You can open multiple Traditional IRAs, multiple Roth IRAs, or both. However, your total contributions across all IRAs cannot exceed the annual limit. If you have three IRAs and contribute $2,000 to each, you have hit the $6,000 limit (assuming that is the current limit for your age) and cannot add more that year.

What happens to my IRA if I die?

Your IRA passes to the beneficiary you named when you opened the account. That person inherits the account and can withdraw the money, though they may owe income taxes on withdrawals. The rules for inherited IRAs are complex and depend on whether the beneficiary is a spouse, child, or other person, and when you died. A spouse can treat an inherited IRA as their own; others typically must withdraw within ten years.

Can I borrow money from my IRA?

You cannot take a loan from an IRA the way you can from a 401(k). You can only withdraw money, and early withdrawals come with penalties and taxes. Some people use a workaround called a "60-day rollover" to temporarily access funds, but this is risky and can result in penalties if not executed correctly.

Do I need earned income to open an IRA?

Yes, you must have earned income (wages, self-employment income, or similar) to contribute to an IRA in a given year. The amount you can contribute cannot exceed your earned income. A spouse with no income can contribute through a spousal IRA if the working spouse has enough income to cover both.

What is the difference between an IRA and a 401(k)?

An IRA is an account you open yourself; a 401(k) is offered by your employer. A 401(k) often includes employer matching contributions (assistance programs), has higher contribution limits, and allows loans. An IRA gives you more control over investments and can be opened by anyone with earned income. Many people use both—a 401(k) through work and an IRA on the side.