- IRAs offer a wide range of investment choices through the account custodian. These typically include individual stocks and bonds as well as ETFs and mutual funds.
- IRAs can often be invested in lower-cost choices than those available in some 401(k)s.
- Contributions to a traditional IRA can be made on a pre-tax basis.
- Money invested in an IRA grows either tax-deferred in the case of a traditional IRA or tax-free in the case of a Roth IRA.
- There are IRAs available for various situations, including traditional and Roth IRAs. Additionally, a SEP-IRA or a SIMPLE IRA can be used by small businesses and the self-employed.
- IRAs offer a solid rollover destination for money from a former employer’s retirement plan when you leave the company.
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Updated March 11, 2024
In a nutshell
An Individual Retirement Account (IRA) is a type of tax-advantaged retirement savings account that can be used on its own or in conjunction with other types of retirement savings accounts like a workplace 401(k).
- An IRA’s tax advantage allows your investments to grow tax free.
- You pay no income tax on money contributed to a traditional IRA up to certain income thresholds, but you pay income tax on the distributions after you retire.
- Roth IRAs are funded with after-tax dollars, but the investments grow tax free and distributions are tax free.
What is an IRA?
An IRA is a tax-advantaged account opened at a traditional broker like Merrill Lynch, through a bank, through some fund companies that serve as custodians like Vanguard or Fidelity, and through a growing number of online brokers.
IRAs come in several varieties with different tax treatments and contribution levels. In all cases, the money contributed to the account or rolled over to the account from another source, like a 401(k), grows on a tax-deferred or tax-free basis.
For those with no access to a workplace retirement plan like a 401(k), an IRA can be an essential vehicle for tax-advantaged retirement savings. An IRA works well in conjunction with a 401(k) or other type of retirement plan as well. In addition to any annual contributions made, IRAs are an excellent destination for rolling over a 401(k) or similar plan when you leave an employer.
How does an IRA work?
Money invested in an IRA account grows tax-deferred or tax-free in the case of a Roth IRA. The amount that accumulates in the IRA depends on how much you contribute over time and how you invest the money in the account.
IRAs have annual contribution limits. For 2024 these are $7,000 with an additional $1,000 catch-up contribution for those who are 50 or over. Contributions for the current tax year can be made up to the tax filing date, excluding any extensions. This is usually April 15th of the following calendar year. Contributions can only be made if you have earned income from employment or self-employment.
Types of IRAs
The two main types of IRAs are Roth and traditional. The annual contribution limits for IRAs are for all types of IRAs combined.
Traditional IRA
Contributions to a traditional IRA often can be made on a pre-tax basis. The exception to this occurs if you or your spouse are covered by a retirement plan, such as a 401(k), at work. In this case, there are income restrictions that limit or prohibit the ability to make pre-tax contributions. After-tax contributions can also be made to a traditional IRA.
Distributions from a traditional IRA are taxable, with the exception of any after-tax contributions made to the account. Distributions taken prior to age 59 ½ are generally subject to a 10% early withdrawal penalty in addition to any taxes due.
Traditional IRA accounts are subject to required minimum distributions (RMDs) at age 72 (73 if you reach age 72 after Dec. 31, 2022).
If you or your spouse are covered by a workplace retirement plan, such as a 401(k), there are income limitations above which contributions to a traditional IRA cannot be made on a pre-tax basis. For 2024, these modified adjusted gross income (MAGI) limits are:
| Filing status | MAGI limits | Deductions |
|---|---|---|
Married filing jointly or qualified widow(er) | Less than $123,000 | Full deduction |
$123,000 to less than $143,000 | Partial, prorated deduction | |
$143,000 or above | No deduction | |
Married filing jointly or qualified widow(er) and your spouse is covered by a workplace retirement plan | Less than $230,000 | Full deduction |
$230,000 to less than $240,000 | Partial, prorated deduction | |
$240,000 or above | No deduction | |
Single or head of household | Less than $77,000 | Full deduction |
$77,000 to less than $87,000 | Partial, prorated deduction | |
$87,000 or above | No deduction | |
Married filing separately | Less than $10,000 | Partial deduction |
$10,000 or above | No deduction |
Roth IRA
Contributions to a Roth IRA are made on an after-tax basis; there is no upfront tax benefit. If certain conditions are met, withdrawals from a Roth IRA are tax-free. Money invested in the account is allowed to grow tax-free as well.
The money contributed to a Roth IRA can always be withdrawn. But withdrawals from a Roth IRA prior to age 59 ½ that also have not met the five-year rule for contributions to a Roth IRA could be subject to taxes and a 10% penalty. There are exceptions to the penalty for withdrawals related to certain situations and hardships.
Roth IRAs are not subject to required minimum distributions.
Roth IRA contributions are subject to income restrictions based on your MAGI. The limits for 2024 are:
| Filing status | MAGI limits | |
|---|---|---|
Married filing jointly or qualified widow(er) | Less than $230,000 | Full contribution limit |
$230,000 to less than $240,000 | Partial, prorated contributions | |
$240,000 or above | No contributions allowed | |
Single or head of household | Less than $146,000 | Full contribution limit |
$146,000 to less than $161,000 | Partial, prorated contributions | |
$161,000 or above | No contributions allowed | |
Married filing separately | Less than $10,000 | Contribution is reduced |
$10,000 or above | No contributions allowed |
Rollover IRA
A rollover IRA can be either a traditional or Roth IRA that you open to receive a rollover from a 401(k) or other retirement plan when leaving an employer. The reason to establish a rollover IRA is to keep these funds separate in the event you want to roll them over to a 401(k) at a new employer. A rollover IRA will help ensure that these funds are not commingled with other IRA money that might not be eligible for a rollover.
SEP-IRA
A SEP-IRA is a type of IRA that can be established by an employer or a self-employed person. Contributions to a SEP-IRA can only be made by the employer. SEP stands for simplified employer pension.
Contribution limits for 2024 are the lesser of $69,000 or 25% of employee compensation. This percentage may be lower in some cases for those who file a Schedule C as a sole proprietor, as always, it is best to check with your tax professional on this.
While a SEP-IRA can include employees, this can get expensive for the business owner as they must contribute the same percentage of salary for any employees as they do for themselves.
Money in a SEP-IRA can be invested in a variety of investment types, including stocks, bonds, mutual funds, ETFs, and others. A SEP-IRA can be established and funded up to your tax filing date for a given tax year, including extensions.
In addition to the longstanding traditional SEP IRA, The Roth SEP IRA was created in 2023 as part of the SECURE Act 2.0. Funds you place in a Roth SEP IRA may be taken out at any point without tax or penalty since you’ve already paid tax on the money. Any earnings withdrawn before the age of 59 ½ are subject to a 10 percent tax penalty.
SIMPLE IRA
A SIMPLE IRA is a type of retirement plan for small businesses and the self-employed.
SIMPLE IRAs are limited to businesses with 100 or fewer employees. They offer minimal reporting requirements and are meant to be an easy retirement plan option for smaller employers.
Each employee must have their own account at the plan custodian. The contribution limits for 2024 are $16,000, with a $3,500 catch-up contribution available for those employees who are 50 or over. Employers must offer a matching contribution. This can be made as a flat 2% contribution for all employees regardless of how much they contribute or as a dollar-for-dollar match of up to 3% of their salary contributed to the plan. As with SEP IRAs, SIMPLE IRAs may be either traditional (pre-tax) or Roth (after-tax).
Pros and cons of an IRA
There are a number of pros and cons to IRAs.
Pros:
Cons:
- IRA contribution limits are relatively low.
- There are income restrictions on the ability to make pre-tax contributions to a traditional IRA if you are covered by a retirement plan offered by your employer.
- There are income restrictions that limit your ability to contribute to a Roth IRA.
- IRAs generally offer less protection from creditors than a 401(k).
How to open an IRA
IRA accounts can be opened at most banks, brokers, many credit unions, online brokers, and even some robo advisors. You will need to complete an application and then fund the account at some point. You can generally open the account well in advance of making a cash contribution or rolling money over from a workplace retirement plan or another IRA. Each institution will likely have its own rules and may charge a fee.
Frequently asked questions (FAQs)
Is an IRA the same as a 401(k)?
While both are retirement accounts, they are completely different. A 401(k) is offered through an employer and is governed by rules set forth by the Department of Labor. An IRA is an account opened by an individual investor. There are different contribution limits. Unlike a 401(k), an IRA account holder has a much larger choice of investments they can consider.
When can I withdraw from the IRA?
Withdrawals can be made at any time from an IRA. Withdrawals made prior to age 59 ½ may be subject to a penalty.
Can you lose money in an IRA?
Just like any other investment account, you can lose money in an IRA. How much you gain or lose will depend totally on how the money in the account is invested.
AP Buyline’s content is created independently of The Associated Press newsroom. Our evaluations and opinions are not influenced by our advertising relationships, but we might earn commissions from our partners’ links in this content. Learn more about our policies and terms here.