What Is an IRA? How Individual Retirement Accounts Work

An individual retirement account (IRA) is a tax-advantaged account that helps you invest for retirement. Money can grow tax-free or tax-deferred, depending on the type of IRA.

Anyone earning an income is eligible to open a traditional IRA. Other types of IRAs, such as Roths, have income limits, which means high earners may not be able to contribute.

An IRA can be opened through a bank, broker or robo-advisor.

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

How does an IRA work?

IRAs work by allowing you to deposit money from a bank account or other source. Once you've funded the IRA, you can select investments, such as stocks, bonds or mutual funds.

How your account balance grows over time depends on how much you contribute to the IRA and how you invest. (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, the accounts are subject to contribution limits set by the IRS. And because IRAs are intended to be used for retirement, there are also withdrawal rules: You may face a 10% penalty and income taxes if you withdraw money from a traditional IRA before age 59 ½, unless you qualify for an exception^[0]

» Are you on track for retirement? Use our retirement calculator to find out.

IRA benefits

A big benefit of an IRA is that the money you invest grows either tax-free or tax-deferred.

• If you contribute to a traditional IRA, you may 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, you do not receive an immediate tax deduction or benefit, but your retirement distributions 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, tax savings.

IRA contribution limits

One downside of IRAs is that annual contributions are quite low and generally not enough to fund retirement on their own. For Roth and traditional IRAs — the most common types of individual IRAs — you can contribute up to $7,000 in 2024 and 2025 ($8,000 if age 50 and older). Both types of accounts also have additional restrictions:

• If you or your spouse have a retirement plan at work, such as a 401(k), your ability to deduct traditional IRA contributions may be reduced or eliminated. Learn more about the traditional IRA income and deduction limits.

• At certain higher incomes, your ability to contribute to a Roth IRA will be eliminated. The maximum Roth IRA contribution phases down until it is eliminated completely. Learn more about Roth IRA income and contribution limits.

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 penalty-free distributions from a traditional IRA starting at age 59 ½. 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 a 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

3. SEP IRA

Generally, SEP IRAs are 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 2024, contributions are limited to 25% of compensation or $69,000 ($70,000 in 2025). There's no catch-up contribution at age 50 or older. SEP IRAs require proportional contributions for each eligible employee if business owners contribute for themselves^[0]

» 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 2024 are $16,000, with a catch-up contribution of $3,500 for those 50 or older. That contribution limit is $16,500 in 2025. The catch-up contribution is unchanged in 2025 for most people. Secure 2.0 Act allows for a higher catch-up amount for those age 60 to 63, as well as higher overall and catch-up limits for participants in certain applicable plans.

» 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

Opening 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.