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 The contributions and earnings are able to grow tax deferred, meaning they aren’t typically taxed until they are withdrawn.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.

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.