7 Min Read | Published: April 12, 2024
What Is an Individual Retirement Account (IRA)?
Find out what an Individual Retirement Account (IRA) is, and see different types of IRAs, along with benefits, and contribution guidelines.
At-A-Glance
Retirement planning is the key to long-term financial security.
There are several types of IRAs available to individuals.
An IRA can be self-managed or set up by an employer.
Working for a living is how we cover our financial obligations, but retirement planning is a key part of your long-term financial security. At some point, the goal is to stop working and enjoy the fruits of our labor, but that can’t happen if we don’t have money invested that can generate a retirement income.
An Individual Retirement Account (IRA) is one way to do that. These retirement accounts offer a number of benefits but may not be the right choice for everyone. In this article we’ll look at some things you’ll want to keep in mind if you’re considering an IRA.
What Is an Individual Retirement Account (IRA)?
An individual retirement account (IRA) is a long-term savings account that is used specifically to build retirement savings.
It can be self-managed or sponsored by an employer. The self-managed variety is popular with self-employed individuals and independent contractors,1 but employed individuals can also opt to have a self-managed IRA as well. Employer-sponsored IRAs can also be part of a larger compensation agreement.
Here are some examples of both:
- Traditional IRA: With a traditional IRA, contributions are made with pre-tax dollars. The contributions and earnings are able to grow tax deferred, meaning they aren’t typically taxed until they are withdrawn.
- Roth IRA: Roth IRA contributions are made with after-tax dollars. That means that distributions in retirement are generally tax-free.
- Payroll Deduction IRA: a payroll deduction IRA is an employer-sponsored IRA. The employer sets up the account. The employee makes automatic contributions to it via payroll deductions.
- SEP IRA: A Simplified Employee Pension plan (SEP) is set up by the employer. The employer also funds the plan by making direct contributions to an IRA set up for the employee.
- SIMPLE IRA: A Savings Incentive Match Plan for Employees (SIMPLE) IRA is set up by the employer. Employees contribute to it. The employer matches those contributions.
Employer-sponsored IRAs can be set up as either Traditional IRAs or Roth IRAs.2 The difference is whether contributions are made with pre-tax or after-tax dollars. That choice also affects the taxability of distributions in retirement, so speak with your accountant before making it.
IRA Contribution Limits and Withdrawals
The Internal Revenue Service sets maximum annual contribution levels for IRAs every year. In 2024, that limit is $7,000 for individual IRAs, either traditional or Roth.3 If you’re over fifty years old, the limit goes up to $8,000, so you can “catch up” on contributions in the shortened window before your retirement. The IRS has similar rules for 401(K) and other employer-sponsored plans. Be sure to visit the page: Retirement Topics - IRA Contribution Limits on the IRS website for the most up-to-date contribution limits.
You must be over 59 ½ years old to withdraw money from your IRA without incurring a penalty. If you have a traditional IRA, you’ll be required to take withdrawals from your account starting at age 72. There are no required minimum distributions (RMDs) from a Roth IRA, regardless of age, because the taxes on those funds were paid before you deposited them into your IRA.
Early withdrawals (before age 59 ½) from a traditional IRA with be penalized at the rate of 10% and you’ll need to pay income taxes on them. There are some exceptions where you can avoid that, like a first-time home purchase or qualified medical expenses, but it’s generally a good idea to leave those funds alone as long as you can.
Frequently Asked Questions
Yes. You can have an IRA and a 401(k) at the same time. It’s an effective strategy for retirement that increases the annual amount you can contribute.4
The difference is in how contributions and withdrawals work. Contributions to a Roth IRA are made with after-tax dollars, so withdrawals are tax-free. Contributions to a Traditional IRA are made with pre-tax dollars, which defers the tax liability. You pay taxes when you withdraw the money.5
A Roth conversion is the movement of assets from a traditional, simplified employee pension (SEP), SIMPLE IRA, or from a defined-contribution plan such as a 401(k), to a Roth IRA.6
The Takeaway
Understanding the types of IRAs available, along with their benefits, contribution limits, and tax implications can help you to determine whether an IRA is a good choice for you.
1 “Individual Retirement Account (IRA): What It Is, 4 Types,” Investopedia
2 “Individual Retirement Arrangements (IRAs),” Internal Revenue Service
3 “What Are Individual Retirement Accounts (IRAs)?,” Forbes Advisor
4 “Can I Have a 401(k) and a Roth IRA at the Same Time?,” Experian
5 “Understanding a Traditional IRA vs. Other Retirement Accounts,” Investopedia
6 “Roth IRA Conversion: Definition, Methods, and Example,” Investopedia
Kevin D. Flynn is a financial services provider, business coach, and financial writer. He lives in Leominster, Massachusetts with his wife Evelyn, two cats, and ten wonderful grandchildren.
All Credit Intel content is written by freelance authors and commissioned and paid for by American Express.
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