Getting to Know IRAs

In the United States, there are multiple ways to save and invest for retirement. Many people do so by participating in an employer-sponsored qualified retirement plan, such as a 401(k) plan or a pension plan. But there are also accounts outside of workplace benefits that allow you to invest towards your retirement goals, such as IRAs.

IRA Basics

An IRA is an investment account held at a financial institution that is designated for retirement, which is opened and funded by the individual account owner (i.e., the person saving for retirement, as opposed to an employer). An IRA tends to offer a wide array of investment choices.

The federal tax rules place limits on the amount an individual can contribute to IRAs each year, which the IRS updates each year to reflect cost of living adjustments. Savers who are 50 or older have a higher limit contribution limit, since they’re getting closer to retirement. For example, the 2024 IRA contribution limit is $7,000, or $8,000 for savers aged 50 and above.¹

Traditional vs. Roth IRAs—Potential Tax Advantages

The two most common types of IRAs are the traditional IRA and Roth IRA. The main difference between these two types of IRAs comes down to taxation.

With a traditional IRA, you may be able to claim a deduction on your federal tax return for the amount you contributed (or a portion of such) for that tax year, depending on your circumstances. Your deduction may be reduced or phased out if you or your spouse is a participant in an employer sponsored retirement plan and your modified adjusted gross income exceeds certain thresholds based on your tax return filing status.²

With a Roth IRA, your contributions are made on an after-tax basis, meaning you are not able to claim a deduction on your federal tax return for contributions made in a given tax year, but they have the potential to grow tax-deferred over time. Note that the amount you can contribute to a Roth IRA declines as your modified adjusted gross income increases, as contributions to a Roth IRA are subject to income limits, unlike traditional IRAs which do not have any similar income limit restrictions. However, you must have sufficient earned income to contribute to a traditional or Roth IRA. 

Traditional vs. Roth—How Do You Choose?

Whether you opt for a traditional IRA or a Roth IRA can depend on factors like your current and anticipated income and tax bracket. Generally speaking, a Roth IRA may make sense for a younger worker who expects to retire in a higher tax bracket than the one in which they began their career.

Some savers choose to use a Roth IRA as a complement to their traditional IRA, adding more flexibility to their tax strategy. Using both types of accounts allows you to "mix and match" pre- and post-tax contributions now, and likewise, pre- and post-tax distributions in the future during retirement.

Withdrawing from IRAs

You can withdraw money from an IRA at any time. However, if you make a withdrawal from a traditional IRA before age 59½, you’ll generally be subject to a 10% early withdrawal penalty tax, unless you qualify for an exemption. Distributions of taxable amounts (i.e., tax deductible contributions and tax deferred earnings) from a traditional IRA are subject to taxation at the time of withdrawal, even if withdrawn after you attain age 59 ½. You can make a withdrawal of your non-deductible contributions from a Roth IRA without incurring an early withdrawal penalty tax at any age, but withdrawal of earnings prior to age 59 ½ will generally be subject to a 10% penalty tax.

Traditional IRAs are also subject to Required Minimum Distributions (RMDs) while Roth IRAs are not during the owner’s lifetime (but are subject to after-death RMDs following the Roth IRA owner’s death). An RMD is the amount you must withdraw from your retirement account each year once you attain the age at which you must start taking RMDs (“RMD Age”), which depends on the year in which you were born. RMD Age is (a) age 70 ½ for individuals born before July 1, 1949, (b) age 72 for individuals born after June 30, 1949, but before 1951, (c) age 73 for individuals born after 1950, but before 1960, or (d) age 75 for all others.

IRA Rollovers

If you switch jobs throughout your career, you may have a number of options for those assets held in your former employers’ 401(k) plans for which you were a plan participant. One possibility you may consider is rolling the funds in a 401(k) plan account over into an IRA. This allows you to keep the money invested, continue contributing and potentially access a wider range of investment options.

Keep in mind, a rollover from a qualified retirement plan to an IRA is just one option for handling assets remaining in old employer’s 401(k) plan. Depending on the rules of the plan, you may be able to keep the account where it is (though you’ll no longer be contributing to it) or roll it over to your new employer’s plan (if one is available, and if rollovers are permitted). If you cash out the account entirely, you will have to pay taxes on the taxable amount and may face a tax penalty.

You should carefully consider your unique financial needs and personal retirement strategy—and consult your legal and tax advisors—when deciding between the options available to you.

The Bottom Line

Saving for a comfortable retirement is a big task, and the sooner you get started, the more time your money may have to potentially work for you. An IRA can be a great way to save for this purpose, either in the absence of or as a complement to a retirement plan offered at work.

Footnotes:

1 IRS.gov, "IRA Contribution Limits." Available here: https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits. Accessed January 7, 2025

2 IRS.gov, "IRA Deduction Limits." Available here: https://www.irs.gov/retirement-plans/ira-deduction-limits(opens in a new tab). Accessed January 7, 2025