An IRA is a tax-advantaged savings account designed specifically for retirement

An IRA (Individual Retirement Account) is a savings account that the U.S. government created to help people set money aside for retirement. The main benefit is tax relief: depending on which type of IRA you open, you either pay no taxes on the money you contribute now, or you pay no taxes on the growth and withdrawals later. This tax advantage is the reason IRAs exist — it makes saving for retirement cheaper than keeping the same money in a regular bank account.

You open an IRA through a bank, brokerage firm, credit union, or insurance company. You then decide how much to contribute each year (up to a legal limit that changes annually), and you choose what to invest that money in — usually stocks, bonds, mutual funds, or a mix. The account sits in your name, and you control it. The government does not manage it or tell you how to invest; the financial institution you choose does.

The catch is that IRAs are meant for retirement. If you withdraw money before age 59½, you typically owe income tax on the withdrawal plus a 10 percent penalty. There are narrow exceptions — first-time home purchase, medical hardship, disability — but the general rule is: money in, money stays until you are older.

Key Takeaways

  • An IRA is a retirement savings account where contributions or growth may be tax-free, depending on the type you choose.
  • You open an IRA through a financial institution and decide how much to contribute each year within legal limits.
  • The two main types are Traditional IRAs (tax deduction now, taxes on withdrawal later) and Roth IRAs (no tax deduction now, tax-free withdrawal later).
  • Early withdrawal before age 59½ usually triggers income tax plus a 10 percent penalty, with limited exceptions.
  • IRAs are separate from employer retirement plans like 401(k)s, though you can have both.

Traditional IRA versus Roth IRA: the core difference

The two main IRA types differ in when you get the tax break. With a Traditional IRA, you deduct your contribution from your income taxes in the year you make it — so a $7,000 contribution might lower your tax bill that year. But when you withdraw money in retirement, you pay income tax on the full amount. With a Roth IRA, you do not get a tax deduction when you contribute, but withdrawals in retirement are completely tax-free, including all the growth your money earned.

Which one makes sense depends on your income now versus your expected income in retirement. If you are in a high tax bracket now and expect to be in a lower one later, a Traditional IRA saves you more money. If you are in a low bracket now and expect to be higher later, a Roth IRA is usually better. If you are unsure, a Roth is often the safer choice for younger savers because tax rates may rise in the future.

There are also income limits for Roth contributions — if you earn above a certain amount, you cannot contribute to a Roth directly. Traditional IRAs have no income limit, but if you have a workplace retirement plan and earn above a threshold, you cannot deduct your Traditional IRA contribution. These limits change each year.

Contribution limits and how much you can save per year

The IRS sets an annual limit on how much you can put into an IRA. For 2024, that limit is $7,000 per person (or $8,000 if you are age 50 or older, thanks to a "catch-up" provision). This limit applies to the combined total of all IRAs you own — if you have both a Traditional and a Roth, your contributions to both cannot exceed $7,000 in a single year.

The limit changes most years, usually rising by $500 or $1,000 when inflation reaches a certain threshold. You can find the current year's limit on the IRS website or ask your financial institution. If you contribute more than the limit, the IRS charges a 6 percent penalty tax on the excess each year until you remove it.

You can contribute to an IRA as long as you have earned income (wages, self-employment income, or certain other types). If you have no income in a year, you cannot contribute. If you are married and one spouse has no income, you may be able to contribute to a spousal IRA in that spouse's name, using the working spouse's income.

How investment choices work inside an IRA

Once you open an IRA and deposit money, you choose what to do with it. Most people invest in mutual funds, exchange-traded funds (ETFs), individual stocks, or bonds. Some IRAs also allow you to hold certificates of deposit (CDs) or money market funds. The financial institution you chose provides a menu of investment options, and you pick from that menu.

You can change your investments as often as you want without penalty — moving money between funds within the same IRA account is not a taxable event. However, if you withdraw cash from the IRA to move it to a different financial institution, you have 60 days to deposit it into another IRA, or it counts as a withdrawal and triggers taxes and penalties.

If you do not want to choose investments yourself, some financial institutions offer target-date funds or robo-advisor services that automatically adjust your mix of stocks and bonds as you get closer to retirement. These are popular for people who prefer a hands-off approach.

Required minimum distributions and withdrawals in retirement

Once you reach age 73 (as of 2023; this age has been rising gradually), the IRS requires you to withdraw a minimum amount from a Traditional IRA each year. This is called a required minimum distribution (RMD). The amount depends on your age and the total balance of your Traditional IRAs. If you do not take the RMD, you owe a penalty of 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 during your lifetime, which is one reason they are popular with people who do not need the money in retirement and want to leave it to heirs. However, heirs who inherit a Roth IRA do have to take distributions, though those distributions are still tax-free.

You can withdraw money from a Traditional IRA before age 59½ without penalty in a few situations: if you become disabled, if you have large medical expenses, if you are unemployed and need health insurance, or if you are a first-time home buyer (up to $10,000 lifetime). These exceptions are narrow and require documentation, so check IRS rules before assuming you may have access to.

IRAs versus employer retirement plans like 401(k)s

An IRA is not the same as a 401(k) or other workplace retirement plan. A 401(k) is offered by your employer, and your employer may match a portion of your contributions (assistance programs). An IRA is something you open on your own, and there is no employer match. However, you can have both: you can contribute to your employer's 401(k) and also open and contribute to an IRA in the same year, as long as you stay within each plan's contribution limits.

If you leave a job, you can roll over the balance in your 401(k) into a Traditional IRA without paying taxes or penalties. This is called a rollover, and it is a common way people move retirement savings from one employer to another. You cannot roll a 401(k) into a Roth IRA directly, but you can roll it into a Traditional IRA first and then convert it to a Roth (though you will owe taxes on the conversion).

Who should open an IRA and when to start

Anyone with earned income can open an IRA, and there is no age limit to start. The earlier you open one, the more time your money has to grow. Even if you have a 401(k) through work, opening an IRA gives you additional tax-advantaged savings room. If you are self-employed, an IRA is often a good first step before considering a Solo 401(k) or SEP-IRA, which allow higher contributions but are more complex to set up.

You can open an IRA at almost any financial institution: banks, brokerages like Fidelity or Vanguard, credit unions, and robo-advisors. There is no cost to open one, though some institutions charge annual maintenance fees (usually $0 to $25). Shop around, because fees and investment options vary.

Frequently Asked Questions

Can I have more than one IRA?

Yes, you can have multiple IRAs at different institutions. However, your total contributions across all IRAs in a single year cannot exceed the annual limit ($7,000 in 2024, or $8,000 if age 50+). If you have a Traditional IRA and a Roth IRA, they share the same limit.

What happens to my IRA if I die?

Your IRA passes to whoever you named as beneficiary on the account. They inherit it tax-free (though they may owe taxes on withdrawals, depending on the IRA type). If you did not name a beneficiary, the account goes through your estate, which is slower and more complicated. Name a beneficiary when you open the account.

Can I withdraw money from my IRA to buy a house?

First-time home buyers can withdraw up to $10,000 from a Traditional or Roth IRA without the 10 percent early withdrawal penalty. You still owe income tax on the withdrawal from a Traditional IRA, but not from a Roth. This is a one-time lifetime limit, so use it carefully.

What is the difference between a rollover and a transfer?

A transfer moves money directly from one IRA to another at different institutions with no tax consequence. A rollover means you withdraw the money and have 60 days to deposit it into another IRA; if you miss the deadline, it counts as a withdrawal and triggers taxes and penalties. Direct transfers are safer.

Do I have to invest my IRA in stocks?

No. You can hold bonds, CDs, money market funds, or even keep cash in your IRA. However, cash in an IRA typically earns very little interest, so most people invest it. Ask your financial institution what options are available in their IRAs.