Retirement is the most expensive financial goal that most people save for. Many workers have access to a 401(k) plan through their job — and maybe even an employer match — which can go a long way in helping someone reach their retirement goals.
But a 401(k) isn’t right for everyone. First, not everyone has access to a 401(k) plan. And even those that do may max out their plan and need another tax-advantaged option, or they may simply prefer the flexibility and ownership of an account outside their employer.
That’s where an IRA comes in.
If you’re new to retirement planning, you might be wondering what is an IRA account.
To maximize your retirement savings, you need to know what is an IRA account and its advantages.
This popular type of retirement account offers plenty of tax advantages and helps you make even more progress toward your financial goals. Keep reading to learn more about how IRAs work, the different types of IRAs, the rules for these accounts, and much more.
What Is An IRA?
An IRA — short of individual retirement account — An IRA account provides tax benefits for retirement savings. An IRA is a great option for anyone with earned income, regardless of whether you have access to an employer-sponsored retirement plan.
For workers without a 401(k) or another plan through their work, an IRA can be their primary method of saving for retirement. And for those with a workplace retirement plan, an IRA can serve as a supplement.
You should review the terms of your IRA account annually to ensure it meets your financial goals.
IRA Benefits
One of the key questions people ask is what is the benefit of an IRA account in terms of retirement planning.
Before investing, it’s important to understand what is an IRA account and its benefits.
- Tax Advantages
There are big tax perks to having an IRA. Traditional IRAs let your money grow tax-free, which lowers your tax bill while you’re working, and Roth IRAs let you take money out tax-free when you leave.
- Flexibility
IRAs are different from 401(k)s in that they let you invest in a lot of different things. Your financial plan can be changed to fit your risk tolerance and retirement goals.
Why Invest In An IRA?
People who want to save more for retirement should put their money into an IRA. Many people use an IRA account to supplement their retirement savings.
An IRA account give you options, power over your investments, and important tax breaks that can have a big effect on your long-term savings.
How IRAs Work?
An IRA is similar to any other type of brokerage account you might open.
When setting up an IRA account, consider your current tax bracket and retirement goals.
First, you can generally open this type of account with any major broker, and the good news is, you can open one in a matter of minutes.
The flexibility of an IRA account can make it a valuable tool for long-term financial planning.
Because IRAs are self-managed, you can choose from any investment option you want rather than being limited like you might be with a workplace retirement plan. You’ll have access to stocks, bonds, mutual funds, ETFs, and other assets. You can opt to build your own portfolio, or even invest in a target-date fund that serves as your entire portfolio and adapts with you as you age.
Types Of IRAs
When you decide to open an IRA, you’ll have two primary types to choose from. While they’re similar in several ways, they offer some different tax benefits that may be best suited for different individuals.
Understanding the rules of an IRA retirement account is essential for effective retirement planning.
Below you can learn more about the traditional and Roth IRA to get a better idea of which might be best for your situation.
1. Traditional IRA
A traditional IRA allows workers to make tax-deferred contributions for retirement. The funds you contribute to your traditional IRA are pre-tax. You can take a deduction for your contributions on your tax return, which reduces your taxable income (and, therefore, the amount of taxes you’ll owe that year).
It’s important to note that depending on your income and whether you have an employer-sponsored retirement account, you may not actually be able to deduct your traditional IRA contributions. Anyone without a workplace retirement plan can deduct their full contribution, but those who are covered by a retirement plan at work (or whose spouses are covered one), will face the limitations in the table below:
| Filing Status | Modified AGI | Deduction Allowed |
| Single or head of household | $73,000 or less | Full deduction |
| Single or head of household | $73,000 – $83,000 | Partial deduction |
| Single or head of household | $83,000 or more | No deduction |
| Married filing jointly | $116,000 or less | Full deduction |
| Married filing jointly | $116,000 – $136,000 | Partial deduction |
| Married filing jointly | $136,000 or more | No deduction |
| Married filing separately | Less than $10,000 | Partial deduction |
| Married filing separately | $10,000 or more | No deduction |
While the funds are in the traditional IRA, they will continue to grow tax-deferred. You won’t be on the hook for the capital gains or income taxes that you might be subject to on investment earnings in a taxable brokerage account. Finally, when you begin to withdraw funds during retirement, you’ll pay income taxes on it.
2. Roth IRA
A Roth IRA is another tax-advantaged account to help you save for retirement. While there are some similarities between a traditional and Roth IRA, the major difference is the tax advantages. When you contribute to a Roth IRA, you do so after tax. The money you contribute has already been taxed on your paycheck, and there’s no deduction for your contributions.
The good news is once the funds are in your Roth IRA, you’ll never pay taxes on them again. Like with a traditional IRA, the money in your retirement account grows tax-free without capital gains or income taxes. And when you withdraw the funds during retirement, you’ll do so completely tax-free.
IRA Rules
If the traditional and Roth IRAs sound like excellent tools to help you save for retirement, it’s because they are. But if you’re considering opening this type of account, it’s important to understand a few rules you’ll be subject to.
Contribution Limits
The IRS only allows you to contribute up to $6500 per year to either a traditional or Roth IRA. If you’re age 50 or older, you can have an additional catch-up contribution of $1,000 for a total of $7500.
One important rule for IRA limits is that you can’t contribute more than your taxable compensation for the year. So if you earned $6,500 or more, then you’re free to contribute up to the $6,500 contribution limit. But if your income for the year was only $4,000, then that would be the most you could contribute.
The one exception to this rule is if your spouse has earned income. Often referred to as a spousal IRA, stay-at-home parents and other non-working spouses can use their spouse’s taxable compensation to be eligible to contribute to an IRA. Both spouses can contribute up to $6,500 separately. However, the combined contributions can’t exceed the spouse’s total taxable compensation.
Eligibility
Anyone can contribute to a traditional IRA, though as we mentioned, not everyone can deduct their contributions. However, the eligibility rules for a Roth IRA are a bit more strict. To contribute to this type of account, you must have income under a certain limit. The table below shows the different contribution rules for various filing statuses and income levels.
| Filing Status | Modified AGI | Contribution Allowed |
| Single or head of household | Less than $138,000 | The full amount |
| Single or head of household | $138,000 – $153,000 | A reduced amount |
| Single or head of household | $153,000 or more | None |
| Married filing jointly | Less than $218,000 | The full amount |
| Married filing jointly | $218,000 – $228,000 | A reduced amount |
| Married filing jointly | $228,000 or more | None |
| Married filing separately | Less than $10,000 | A reduced amount |
| Married filing separately | $10,000 or more | None |
If you aren’t technically eligible to contribute to a Roth IRA, there is still a way to take advantage of these powerful tax benefits. You can use a backdoor Roth IRA to convert your traditional IRA funds to a Roth IRA. There’s no income limit on this type of transaction, but if you’ve already taken a tax deduction of your traditional IRA contributions, then you’ll have to pay income taxes on the amount you convert.
Withdrawal Rules
IRAs are intended to help you save money for stress-free retirement. As a result, the IRS generally doesn’t allow you to withdraw from your account before age 59½. Any funds withdrawn earlier will be subject to a 10% early withdrawal penalty in addition to the taxes owed.
However, there are a few exceptions where the IRS does allow you to withdraw money early. First, when you contribute to a Roth IRA, you’ve already paid income taxes on your contributions. As a result, you can withdraw those at any time without taxes or penalties. However, any investment earnings you withdraw early will be subject to fees.
There are also several other exceptions that apply to both traditional and Roth IRAs:
- Up to $10,000 to buy or build your first home
- Qualified higher education expenses
- Qualified birth or adoption expenses
- Medical expenses that are more than 7.5% of your AGI
- Medical premiums during a period of unemployment
- Disability or death
Required Minimum Distributions
Traditional IRAs are subject to what is known as a required minimum distribution (RMD). Once you reach age 70½, you’re required to start taking minimum distributions from your account. You can withdraw more than the required amount, but you can’t withdraw less. If you don’t meet the RMD requirement, you could be subject to a 50% excise tax on the amount you didn’t withdraw but should have.
RMDs apply only to traditional IRAs, but not to Roth IRAs. In the case of a Roth IRA, you’ve already paid income taxes on your contributions and won’t pay taxes on that money again. As a result, the IRS has no incentive to require that you take distributions before you want to.
Traditional v/s Roth IRA: Which Is Right For You?
One of the biggest questions that people have about IRAs is whether a traditional or Roth IRA is better. There’s not necessarily one type of account that’s better than the other. Instead, it comes down to which is better for your situation.
In general, pre-tax contributions, like those of a traditional IRA, are better if you expect your tax rate during retirement to be lower than your current tax rate. After-tax contributions, like those of a Roth IRA, are better if you expect your tax rate during retirement to be lower than your current tax rate.
But because of the other rules associated with IRAs, there’s a bit more nuance to it, especially for high-income earners. If you have a high income and are covered by a workplace retirement plan, then you aren’t allowed to deduct your traditional IRA contributions. Because of that, it seems that a Roth IRA would make more sense. However, high-income earners also can’t contribute to a Roth IRA.
Luckily, you still have a couple of options. First, if you have a high income and believe the pre-tax retirement contributions are better for your situation, then you can focus on maxing out your workplace retirement plan before resorting to an IRA. And if you do contribute to an IRA, because you can’t deduct your contributions anyway, it makes sense to take advantage of the Roth conversion to take advantage of that tax benefit instead.
IRA v/s 401(k)
When comparing what is an IRA account vs 401k, it’s crucial to consider contribution limits and tax implications.
For many workers, the 401(k) plan is their first foray into investing for retirement (or investing at all). You might be wondering just how an IRA differs from a 401(k) and which is better.
Before we talk about the differences between a 401(k) and an IRA, we should first talk about their very important similarity: their tax advantages. Just like an IRA, a 401(k) offers tax-free growth on your investments. You can also choose between traditional or Roth contributions to take advantage of the tax benefit that works best for you.
Now that we’ve talked about that important similarity, let’s talk about a few key differences between the 401(k) and the IRA.
One major difference between a 401(k) and an IRA is how they’re offered. 401(k) plans are typically offered by for-profit companies for their employees. An IRA, on the other hand, is an individual account that anyone can set up for themselves.
Another major difference between a 401(k) and an IRA is the contribution limit. Remember how the IRS only allows you to contribute up to $6,500 to an IRA? Well in the case of a 401(k), you can contribute up to $23,000 per year, and individuals age 50 or older can have a catch-up contribution of an additional $7,500. Additionally, your employer can make contributions to your account for a combined total with your contributions of up to $66,000.
The final important difference between a 401(k) and an IRA is the investment options. As we mentioned, an IRA is unlimited in your investment options. You can choose from any investment offered by the brokerage firm you choose. But with a 401(k) plan, your employer puts together a menu of investment options that’s usually relatively small. And you can only choose from the investments on that list.
As far as choosing between a 401(k) and an IRA, it depends on a variety of factors. If your employer offers a matching contribution, be sure to contribute at least enough to take advantage of the entire match. But after that, you can choose to continue contributing to your 401(k) plan, contribute to an IRA instead, or do a combination of both.
IRAs For Self-Employed People
The two IRA options we discussed above are available to anyone, but there are also a couple of options specifically designed for self-employed individuals. Of course, you can use a traditional or Roth IRA if you’re self-employed. But the options we’ll discuss in this section combine some of the benefits of an employer-sponsored retirement plan with those of an IRA.
SEP IRA
A Simplified Employee Pension (SEP) IRA is designed for self-employed individuals, especially freelancers and contractors. With this type of account, you can set aside up to $66,000 or 25% of your income, whichever is less. If you have employees in your business, you can also contribute to accounts for them as well.
SIMPLE IRA
A Savings Incentive Match Plan for Employees (SIMPLE) IRA is another type of retirement account for self-employed individuals. If you choose this plan and have employees, you are required to contribute to their accounts as well.
For 2024, employees can contribute up to $15,500 to a SIMPLE IRA. Employers are required to make contributions as well, either through a matching contribution of up to 3% of the employee’s compensation or a non-elective contribution of 2% of the employee’s compensation.
How To Open An IRA?
You can easily open an IRA through any major brokerage firm. Most popular brokers offer both traditional and Roth IRAs, meaning you can choose the one that works best for you. In general, there are two places you should consider for housing your IRA:
- Brokerage firm: Major brokerage firms like Vanguard, Fidelity, and Schwab make it easy to open your own IRA. When you choose one of these platforms, you can choose your own investments for your retirement portfolio.
- Robo-advisor: A robo-advisor is technically a type of brokerage firm, but instead of one where you choose your own investments, the robo-advisor does it for you. You answer a few questions based on your investment goals and risk tolerance and the platform chooses your investments on your behalf.
5 Best IRA Companies
(1) Wealthfront
Why It’s Great: Wealthfront is a leading robo-advisor that simplifies investing with automated portfolio management. For both new and seasoned investors, it provides a combination of low-cost ETFs, tailored financial planning, and tax-loss harvesting.
Key Features:
- Automatic rebalancing and tax-loss harvesting
- Comprehensive financial planning tools
- Access to high-interest cash accounts
- Customizable portfolios with socially responsible investing (SRI) options
Best For: Investors looking for a hands-off approach to growing their wealth, with sophisticated tools for optimizing tax efficiency and long-term gains.
(2) Fidelity Investments
Why It’s Great: With no account fees and no minimum investment requirements, Fidelity Investments has a large spectrum of investing alternatives including mutual funds, ETFs, and individual stocks. Their strong research tools and customer support help novice as well as experienced investors to handle their IRAs.
Key Features:
- $0 commission on trades
- Access to a vast selection of low-cost mutual funds and ETFs
- Excellent mobile app and online tools for portfolio management
Best For: Investors looking for comprehensive tools, educational resources, and low fees.
(3) Vanguard
Why It’s Great: Vanguard is a trailblazer in low-cost investing; it provides a large range of mutual funds and ETFs with some of the lowest industry fee ratios. Retirement savings especially like them because of their emphasis on low fees and long-term growth.
Key Features:
- Wide selection of low-cost index funds
- No commission on most online transactions
- Long-term investment focus with a reputation for client-first service
Best For: Investors focused on long-term growth and cost efficiency.
(4) Betterment
Why It’s Great: Leading robo-advisor Betterment is ideal for people who like a hands-off approach. With low costs and tax-efficient techniques to maximize your retirement savings, they provide automatic portfolio management depending on your goals.
Key Features:
- Automatic rebalancing and tax-loss harvesting
- Personalized investment advice based on your retirement goals
- Low annual fees (0.25% to 0.40%)
Best For: Investors who prefer automated, low-cost retirement planning.
(5) Fundrise
Why It’s Great: Fundrise was one of the first companies to use crowdfunding to buy real estate. It lets regular people invest in private real estate markets that were once only open to wealthy people. Without leaving their easy-to-use website, Fundrise lets you put your money into a wide range of real estate projects all over the country.
Key Features:
- Low minimum investment ($10) to get started
- Access to diversified real estate portfolios with consistent dividend payouts
- Automatic reinvestment options to maximize growth
- Detailed project updates and performance tracking
Best For: Investors looking to diversify their portfolios with real estate, without the hassle of directly managing properties. Fundrise is ideal for those interested in long-term growth and income from real estate, with a hands-off investment approach.
Conclusion
When it comes to choosing the right platform, you should first consider whether a traditional brokerage firm or robo-advisor works best for your needs. After that, you can compare individual platforms by comparing the investments available, fees, user interface, and other factors that are important to you.
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FAQs
Opening an IRA just requires one dollar, but many brokerages want at least $500 to $1,000 in contributions.
Each has merits unique to its own. If you can get one, a 401(k) could be better—especially if your workplace matches the money you contribute. Your 401(k) is only going to enable you to save so much money. Still more can be saved with an IRA.
An IRA’s money you fund does increase with time. If you take advantage of compound interest, you could make really large gains.
Taking money out of a Traditional IRA is taxed as income; you can invest less money into an IRA than a 401(k. Those who earn a specific level of income also cannot fund Roth IRAs.
