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Saving enough money for retirement can be a challenge no matter who you are, but it’s a challenge worth tackling early and sticking with for a lifetime. To make the process easier — and more lucrative — many Americans open individual retirement accounts, better known as IRAs.
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An IRA is a type of financial account designed to help people build retirement savings over the course of many years. It’s a good way to get started at a young age, especially if you don’t have access to a 401(k) or other type of company-sponsored retirement plan.
IRAs offer tax advantages and investment options that help you grow your nest egg faster than if you simply planted your money in a traditional savings account. There are a few different types of IRAs to choose from, each suited to different needs. Keep reading to learn about the different types of IRAs and their advantages (and disadvantages).
What Is an IRA?
In simple terms, an IRA is a tax-advantaged retirement savings account. Several types of IRAs are available, each with its own rules. Contributions to some IRAs are tax deductible, and certain withdrawals are tax-free.
Unlike other savings options, IRAs offer different ways to grow your retirement fund by letting you put your money into stocks, bonds, mutual funds, exchange-traded funds and other assets. This can help your account balance compound quickly compared to savings accounts, certificates of deposit and money market accounts.
You can open IRAs with brokers, investment firms, banks, credit unions and other financial institutions. Certain brokers might charge annual fees and commissions, though not all do. You can also earn bonuses for opening IRAs with high initial deposits.
Types of IRAs
The two most popular individual retirement accounts are traditional IRAs and Roth IRAs, but they aren’t the only options. Here’s an overview of the different types.
Traditional IRA
This is the most popular IRA type and is available to anyone with earned income. Here are some things to know about a traditional IRA:
- Annual contributions/limits: As of 2024, you are allowed to contribute $7,000 a year to a traditional IRA. If you are 50 or older, you can make an additional catch-up contribution of $1,000, for an annual limit of $8,000.
- Taxes: The balance in your traditional IRA will continue to grow on a tax-deferred basis until you take a distribution, also known as a withdrawal. You might also be able to deduct part of all of your contributions from your taxes. With few exceptions, you’ll face a penalty if you take a withdrawal prior to age 59 ½.
- Withdrawals: After reaching age 59 ½, you can access funds without penalties or restrictions. When you hit age 72 or 73 (depending on your birth year), you must begin taking required minimum distributions.
Roth IRA
With a Roth IRA, you invest money using after-tax dollars, meaning taxes are not deferred and contributions are not deductible. However, when you reach the distribution stage, your money can be withdrawn tax-free. Eligibility for a Roth IRA is based on your income level (you can learn more by visiting the IRS site). The contribution limits for a Roth IRA are the same as a traditional IRA. As with traditional IRAs, you could face a penalty for withdrawing funds from your Roth IRA before age 59 ½.
SIMPLE IRA
Also known as a Savings Incentive Match Plan for Employees IRA, this type of IRA is designed for small businesses with fewer than 100 employees. SIMPLE IRA plans are similar to traditional IRAs and feature tax-deferred and tax-deductible contributions. Employees can contribute up to $16,000 in 2024, with an additional $3,500 catch-up contribution for those 50 or older. Employers are required to provide up to a 3% matching contribution or a 2% fixed contribution of each eligible employee’s compensation, according to U.S. Bank.
SEP IRA
The Simplified Employee Pension IRA is a traditional IRA that employers can set up for themselves and their workers. Contributions are made by the employer and change yearly based on the business’s cash flow, according to U.S. Bank. For tax year 2024, contributions are limited to the lesser of the following: 25% of employee compensation, or $69,000. You can’t make catch-up contributions with a SEP IRA, though your earnings grow tax-free and are subject to most of the same rules as traditional IRAs.
Pros and Cons of an IRA
As with any type of financial account, IRAs have their advantages and disadvantages. Here’s a breakdown:
Pros
- Your balance grows tax-free with traditional IRAs, which encourages saving money at an early age.
- IRAs often have lower fees than 401(k)s, according to Wealthfront.
Cons
- IRAs have a low contribution limit of $7,000 per year, which makes it hard to build up savings in a hurry.
- Early withdrawal penalties apply if you take distributions before age 59 ½.
- Required minimum distributions go into effect at age 72 or 73, which means you must make a yearly withdrawal even if you don’t need the money at that point in your life.
What Is an IRA Rollover?
An IRA rollover allows you to move money from one tax-advantaged account to another without triggering any tax consequences. This might apply if you move money from one IRA to another IRA, for example, or from a 401(k) to an IRA.
What Is an IRA Phaseout?
If either you or your spouse are covered by a retirement plan at work, the deductibility of IRA contributions begins to phase out once you’ve earned above a certain level of income. For single taxpayers, the phaseout range in 2024 is between $77,000 and $87,000, according to the IRS. For married couples filing jointly, the phaseout range is $123,000 to $143,000.
FAQ
- Is an IRA the same as a 401(k)?
- An IRA is an individual retirement account. A 401(k), on the other hand, is a retirement plan sponsored by a business.
- A 401(k) has higher contribution limits than an IRA, and it may also offer loans to participants. However, 401(k) plans usually have limited investment options.
- How does an IRA work?
- Like other retirement accounts, you contribute money into your IRA while you are working and earning an income. The contributed money is often used to invest in stocks, ETFs or mutual funds to grow rather than falling behind inflation. Then, after you retire, you can withdraw funds to cover your living expenses, since you are no longer earning an income.
- Unlike employer-sponsored retirement plans, an IRA is an individual account.
Scott Jeffries and John Csiszar contributed to the reporting for this article.
Our in-house research team and on-site financial experts work together to create content that’s accurate, impartial, and up to date. We fact-check every single statistic, quote and fact using trusted primary resources to make sure the information we provide is correct. You can learn more about GOBankingRates’ processes and standards in our editorial policy.
- IRS. 2023. "401(k) limit increases to $23,000 for 2024, IRA limit rises to $7,000."
- Wealthfront. 2024. "What Are the Benefits and Drawbacks of IRAs?"
- U.S. Bank. "Types of IRA accounts."
