What Is An Individual Retirement Account (IRA)? - NerdWallet (2024)

An individual retirement account (IRA) is a tax-advantaged investment account that helps you save for retirement. Money invested in an IRA grows either tax-free or tax-deferred, depending on the type of account you have.

The IRS calls these accounts individual retirement arrangements. IRAs have annual contribution limits, and you’re able to contribute up to the maximum limit set by the IRS each year.

In 2024, you can contribute $7,000 a year to an IRA, or $8,000 if you're 50 or older.

» Ready to get started? Review our best IRA accounts to compare.

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How does an IRA work?

Anyone earning an income is eligible to open an IRA, including people with a 401(k) account through work, a nonworking spouse whose partner is earning an income, or even a minor making their own money.

An IRA can be opened through a bank, broker or robo-advisor, and the money deposited can be invested in stocks, bonds, exchange-traded funds or other assets.

» Are you on track for retirement? Find out with our retirement calculator.

How your account balance grows over time depends on how you invest and how much you contribute to the IRA. (See how to invest your IRA for simple investment strategies.) There are several types of IRAs, including the traditional IRA and Roth IRA for individuals, and SEP IRA and SIMPLE IRA for business owners and self-employed individuals.

While you can have more than one type of IRA, keep in mind that the accounts have a single annual contribution limit. And because the funds are intended to be used for retirement, there are also withdrawal rules: You may face a 10% penalty and a tax bill if you withdraw money before age 59 1/2, unless you qualify for an exception.

Why invest in an IRA?

A big benefit of an IRA is that the money you invest in one grows either tax-free or tax-deferred, depending on the type of IRA you choose.

  • If you contribute to a traditional IRA, you'll get a tax deduction on your contributions in the year they are made; you'll then pay taxes when you take distributions in retirement.

  • If you contribute to a Roth IRA, there is no immediate tax deduction or benefit, but distributions in retirement are tax-free.

But the tax advantages are not the only perk.

“The main benefit of an IRA is your ability to have more investment options and choices,” says certified financial planner Matt Aaron, founder of Washington, D.C.-based Lux Wealth Planning, an affiliate of Northwestern Mutual.

An employer-sponsored 401(k) may have limited investments or may not let you choose your own. And a 401(k) or pension alone may not provide enough money for you in retirement.

Contributing to an IRA can offer you more access to investment options, increased retirement income and, yes, those tax savings.

One downside of IRAs is that annual contributions are limited. You can contribute $23,000 to a 401(k) in 2024 and take advantage of an employer match if it’s offered. IRA contribution limits are much lower.

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IRA contribution limits

In 2023, the maximum you could contribute among all your IRAs was $6,500 ($7,500 if you're 50 or older). In 2024, the max is $7,000 ($8,000 for those 50 or older).

While you can have more than one IRA and contribute to all of them in a single year, the contribution limit is a combined limit.

Traditional IRA contributions may also be tax-deductible, depending on how much you earn.

2024 traditional IRA deduction limits

The income limits on traditional IRA deductions only apply if you (or your spouse) have a retirement plan at work.

Filing status

2024 traditional IRA income limit

Deduction limit

Single or head of household (and covered by retirement plan at work)

$77,000 or less.

Full deduction.

More than $77,000, but less than $87,000.

Partial deduction.

$87,000 or more.

No deduction.

Married filing jointly (and covered by retirement plan at work)

$123,000 or less.

Full deduction.

More than $123,000, but less than $143,000.

Partial deduction.

$143,000 or more.

No deduction.

Married filing jointly (spouse covered by retirement plan at work)

$230,000 or less.

Full deduction.

More than $230,000, but less than $240,000.

Partial deduction.

$240,000 or more.

No deduction.

Married filing separately (you or spouse covered by retirement plan at work)

Less than $10,000.

Partial deduction.

$10,000 or more.

No deduction.

5 types of IRAs

Here are five popular types of IRAs and an overview of each:

1. Traditional IRA

Contributions to traditional IRAs are often tax-deductible. For example, contributing $3,000 to a traditional IRA could reduce the amount of your taxable income by $3,000. However, withdrawals from traditional IRAs in retirement are taxable as ordinary income.

Generally, you can take distributions from a traditional IRA starting at age 59 1/2. If you take money out before then, you may have to pay a 10% penalty (there are some exceptions). You must start taking required minimum distributions when you reach at certain age, depending on the year you were born.

If you're married and you or your spouse has a retirement plan at work, the amount of your traditional IRA contribution that you can deduct is reduced, and eventually eliminated, once you hit a certain income. You can still make contributions, but they won’t be tax-deductible. If you and your spouse don't have retirement plans at work, then you can deduct your IRA contribution no matter how much your income is.

» MORE: Learn more about traditional IRAs

2. Roth IRA

Contributions to Roth IRAs aren't tax-deductible, but regular contributions (excluding Roth conversions) can be withdrawn penalty- and tax-free at any time. Additionally, there are no taxes on investment gains when taken out during retirement. It's an attractive option for investors who have a long time before they retire, says Aaron.

“The question is, do you want to pay your taxes now or later? For me, I’d rather pay taxes now,” says Aaron.

Roth IRAs can help you combat inflation, Aaron says, because money loses value over time. He says he thinks of a Roth IRA as paying taxes on the seed vs. paying taxes on the harvest.

"I don't have the magic ball and I can never say I know what’s going to happen in the future, but if taxes go up, and you’re taking that money out in the future, you get to potentially minimize the taxes you pay.”

There are income limits for Roth IRAs, so the amount you can contribute decreases and is eventually eliminated at certain incomes.

If you earn too much to contribute to a Roth IRA, you can try the backdoor Roth method instead.

» MORE: Learn more about Roth IRAs and how to open one

3. SEP IRA

Generally, SEP IRAs are IRAs for self-employed people or small-business owners with few or no employees. Similar to traditional IRAs, the contributions are tax-deductible. Investments grow tax-deferred until retirement when distributions are taxed as income.

In 2023, contributions were limited to 25% of compensation or $66,000, whichever is less. If you got a tax extension by the April tax deadline, you can still contribute to your SEP IRA until Oct. 15, 2024.

In 2024, contributions are limited to 25% of compensation or $69,000. There's no catch-up contribution at age 50 or older for SEP IRAs. SEP IRAs require proportional contributions for each eligible employee if business owners contribute for themselves.

» MORE: Learn more about SEP IRAs and how to open one

4. SIMPLE IRA

SIMPLE IRAs (Savings Incentive Match Plan for Employees Individual Retirement Accounts) are for small businesses with fewer than 100 employees. Similar to traditional IRAs, the contributions are tax-deductible. Investments grow tax-deferred until retirement, when distributions are taxed as income.

Employee contribution limits for a SIMPLE IRA in 2023 were $15,500 per year for those under age 50. People 50 and older could make an additional $3,500 catch-up contribution for 2023. For 2024, the contribution limit rises to $16,000. The catch-up contribution remains unchanged at $3,500. Employer contributions are mandatory and can be made up until the tax filing deadline (including the extension deadline).

» MORE: Learn more about SIMPLE IRAs and how to open one

5. Rollover IRA

A rollover IRA isn’t exactly a type of IRA account, but a process in which you can transfer eligible assets from an employer-sponsored plan, such as a 401(k), into an IRA. People tend to do this when they're switching jobs so they can house all of their money in one place.

» MORE: Learn more about rollover IRAs

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What Is An Individual Retirement Account (IRA)? - NerdWallet (5)

How to open an IRA

Two popular ways to open an IRA are through brokers and robo-advisors. If you want to choose investments for yourself, an online broker can be a good way to go.

If you want help managing your retirement account, consider a robo-advisor — a service that selects low-cost and risk-appropriate investments for you.

» Ready to get started? Read how to open an IRA for details on moving money into your account

What Is An Individual Retirement Account (IRA)? - NerdWallet (2024)

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