What is an IRA (Individual Retirement Account) and How to Choose One? (2024)

If you’re an employee thinking about how you can save for retirement, individual retirement accounts, better known as IRAs, are worth considering. Almost anyone with earned income can open an IRA, which makes it different from a 401(k), which you can only participate in if your employer offers one. There are several different types of IRAs, each with its own requirements and features, but all offer important tax advantages that could help you save more for your future.

The most popular kinds of IRAs are traditional IRAs and Roth IRAs. The combined maximum yearly contribution to both accounts is $7,000 for 2024—or $8,000 if you will be age 50 or older at any time during the calendar year. Here’s what you need to know to help you choose an IRA.¹

Traditional IRAs provide tax-deferred growth. This means your money grows tax-free until you begin taking distributions, at which point your withdrawals are taxed at your income tax rate.² What’s more, contributions may be tax-deductible. For instance, if you make $40,000 per year and put $3,000 in a traditional IRA, you will generally receive a deduction against your $40,000 of income.

For 2024, if you are covered by a workplace retirement plan, your contributions are at least partially tax-deductible if your modified adjusted gross income is less than $87,000 if you are single or $143,000 if you are married and filing jointly. The income limits are higher if your spouse is covered by a workplace retirement plan but you are not. However, if neither you nor your spouse are covered by a workplace retirement plan, your contributions are tax-deductible no matter what your income is.

A traditional IRA can be useful for those who don’t qualify for a Roth IRA (see next section), for those who anticipate being in a lower tax bracket after retirement and for those who want to save outside their 401(k). It makes sense to invest enough in your 401(k) to get the full matching contribution from your employer, if they offer one. Beyond that, IRAs may offer more investment flexibility than many 401(k)s, though you should learn the details of your 401(k) to be sure. Anyone with earned income³ is eligible to open a traditional IRA. If you withdraw funds from your traditional IRA before age 59½, however, you generally have to pay income tax on any tax-deductible contributions and earnings, and an additional 10 percent tax on your withdrawal—though some exceptions may apply.

Roth IRAs are attractive accounts for those who can afford to pay taxes now for the reward of federally tax-free income later (state taxes may apply). Since contributions to Roth IRAs aren’t tax-deductible, you pay more in income taxes up front than you would with a tax-deductible contribution to a traditional IRA. The trade-off is when you withdraw your contributions, you get to take home the full amount federal tax-free (as long as at least five years have passed since your first Roth IRA contribution and you’re older than 59½ or you meet another exception). In addition, unlike tax-deductible contributions to traditional IRAs, contributions to a Roth IRA can be withdrawn at any time, tax-free (including the 10% early withdrawal tax), although taxes (including the 10% early withdrawal tax) may apply to the portion of the withdrawal representing earnings.

One other feature that sets the Roth IRA apart from the traditional IRA: There are no required minimum distributions while the Roth IRA owner is still alive. However, to contribute for 2024, you must have earned income, and single tax filers must make less than $161,000 per year, while joint tax filers must make less than $240,000 per year. The IRS adjusts these limits annually.

You may contribute to both a traditional and a Roth IRA, though there is an annual contribution limit—for 2024, the maximum combined limit across both accounts is $7,000 (or $8,000 if you will be age 50 or older at any time during the calendar year).

A simplified employee pension (SEP) IRA can be a good option for those who are self-employed. SEP IRAs allow you to set aside up to the lesser of (a) 25% of compensation (as determined under the SEP IRA rules),⁴ or (b) $69,000 through 2024.⁵

SEP IRAs work like traditional IRAs, which means you don’t pay taxes on your contributions and earnings until you withdraw them in retirement. There is no Roth option for SEP IRAs.

Once you determine your account type, you may be able to choose between an investment IRA and a savings IRA. Think about your retirement goals, your financial health and your life stage to help you determine which kind of IRA would be better for you. Savings IRAs are offered by banks and feature FDIC-insured CDs and money market savings accounts. These are lower-risk accounts that offer the potential for relatively stable, modest yearly returns, often without any annual or custodial fees.

Investment IRAs are offered by investment firms and may allow you to invest in stocks, bonds, exchange-traded funds (ETFs) and mutual funds. These accounts may make sense for those who are willing to accept some risk in their retirement accounts in exchange for the potential for greater long-term growth. Investment IRAs are not FDIC-insured, are not bank guaranteed and have the potential to lose value.

No matter which kind of IRA you choose, saving or investing for retirement should be at the top of your list of financial priorities. With retirements lasting longer than they used to, the sooner you start preparing, the better off you could be.