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

Frequently asked questions

What does IRA stand for?

IRA stands for individual retirement arrangement. That’s the official name given by the IRS, but most people think of IRAs as individual retirement accounts, and that’s exactly what they are. While there are different types of IRAs, all of them are retirement accounts that offer tax benefits to encourage people to save for retirement. Almost all IRAs require you to have income from work.

How much money do you need to start an IRA?

Many discount brokers and robo-advisors have $0 minimums to open an IRA. However, the tax perks of investing in an IRA begin only once you've started contributing money to the account. The maximum the IRS allows you to contribute is up to $6,500 in 2023 ($7,000 in 2024). You can contribute an extra $1,000 per year if you’re age 50 or over. You can contribute the full amount, but it is not required.

You can add money to your IRA at whatever cadence and amount works for your budget. Many brokers and robo-advisors allow investors to set up automatic deposits to transfer money from a bank into an account.

Is it better to have a 401(k) or IRA?

You can have both a 401(k) and an IRA. A 401(k) offers more opportunity to increase your retirement savings compared with an IRA. In 2024, the maximum contribution limit is $23,000 for a 401(k) compared with $7,000 for an IRA. If you’re 50 years or older, the catch-up contribution is larger as well, at $7,500 for the 401(k) versus $1,000 for the IRA.

You could consider investing primarily in an IRA if you don't get an employer match, if you plan to max out your 401(k), or if your 401(k) has narrow investment options or high fees.

Can you lose money in an IRA?

Yes. You can put your IRA money in a variety of investments, and some of those investments may lose value.

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

FAQs

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

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.

What is an individual retirement account quizlet? ›

Individual Retirement Account (IRA) A tax sheltered account ideal for retirement investing. It permits investment earnings such as interest, qualifies and non-qualified dividends to accumulate tax free with in the account, super charging the already powerful effect of compound interest.

Is an IRA an individual retirement account? ›

Individual retirement accounts (IRAs) are personal retirement savings accounts that offer tax benefits and a range of investment options. Many investors use IRAs as their common source of saving for retirement.

What are traditional individual retirement accounts ________? ›

A traditional IRA is a tax-advantaged personal savings plan where contributions may be tax deductible.

What is the definition of an IRA for retirement? ›

An individual retirement account (IRA) is a tax-advantaged investment account designed to help you save toward retirement. IRAs are one of the most effective ways to save and invest for the future.

What is an individual retirement account annuity? ›

With an individual retirement annuity, however, you make premium payments to the insurance company rather than contributing deferred salary to an IRA. Later when you retire, rather than taking funds from your IRA to get money to pay expenses, you get regular guaranteed payouts from the insurance company.

What is an individual retirement account that helps you save for retirement? ›

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.

What is the IRA explained? ›

An IRA is an account set up at a financial institution that allows an individual to save for retirement with tax-free growth or on a tax-deferred basis.

What is the difference between an IRA and an individual account? ›

There are no restrictions on how much you can invest in a brokerage account, and you can readily buy, sell, and trade for short-term or long-term potential gain. IRAs, on the other hand, have strict rules around when you can withdraw without penalty as well as how much you can contribute annually.

Is a simple IRA an individual IRA? ›

Key Takeaways. Traditional IRAs are set up by individuals, while SIMPLE IRAs are set up by small business owners for employees and themselves. Traditional IRA contributions are made by the individual only, but SIMPLE IRA contributions can be from both an employee and an employer.

Can you take money out of an IRA? ›

You can take distributions from your IRA (including your SEP-IRA or SIMPLE-IRA) at any time. There is no need to show a hardship to take a distribution. However, your distribution will be includible in your taxable income and it may be subject to a 10% additional tax if you're under age 59 1/2.

What is a traditional IRA simple definition? ›

What Is a Traditional IRA? A traditional individual retirement account (IRA) allows individuals to direct pre-tax income toward investments that can grow tax-deferred. The IRS assesses no capital gains or dividend income taxes until the beneficiary makes a withdrawal.

What is an individual taxable retirement account? ›

A taxable account provides the flexibility to add money and take money out with few limits, penalties, or restrictions. There are also no required distributions. You can save more toward retirement or any other future goal.

How do IRA accounts work? ›

How does an IRA work? When you contribute to an IRA, you can choose to invest your money in the market or put it in an interest-paying account. As that money grows, it isn't taxed, so your savings could grow faster. The specific details and tax benefits of your IRA depend on if you choose a Traditional or Roth IRA.

Who qualifies for a IRA? ›

Individuals who have earned income and their non-working spouses, if filing jointly, can contribute to a Traditional IRA. With a Traditional IRA, you may be able to deduct your contributions on your taxes, which can help lower your tax bill.

How much do you need in your IRA to retire? ›

By age 40, you should have accumulated three times your current income for retirement. By retirement age, it should be 10 to 12 times your income at that time to be reasonably confident that you'll have enough funds. Seamless transition — roughly 80% of your pre-retirement income.

What is individual retirement in economics? ›

An Individual Retirement Account (IRA) is a retirement savings account set up with a financial institution or brokerage firm that offers tax breaks for those investing income for their retirement. IRAs can be opened by an individual, self-employed individuals and small business owners.

What is an individual retirement arrangement or account? ›

An individual retirement arrangement (IRA) is a tax-favored personal savings arrangement, which allows you to set aside money for retirement. There are several different types of IRAs, including traditional IRAs and Roth IRAs. You can set up an IRA with a bank, insurance company, or other financial institution.

Is an individual retirement account a 401K? ›

A 401K is a type of employer retirement account. An IRA is an individual retirement account.

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