An Individual Retirement Account (IRA) is a long-term, tax-advantaged savings account that individuals with earned income can use to save for the future.
The IRA is primarily designed for self-employed people who do not have access to workplace retirement accounts such as the 401(k), which is typically available only through employers. However, anyone with a retirement plan at work can also open an IRA and invest additional savings with it.
You can open an IRA through a bank, an investment company, an online brokerage, or a personal broker.
Key Takeaways
- Individual Retirement Accounts (IRAs) are retirement savings accounts with tax advantages.
- Types of IRAs include Traditional IRAs, Roth IRAs, Simplified Employee Pension (SEP) IRAs, and Savings Incentive Match Plan for Employees (SIMPLE) IRAs.
- Money held in an IRA usually can’t be withdrawn before age 59½ without incurring a hefty tax penalty of 10% of the amount withdrawn.
- Annual income limitations apply to both the deductibility of contributions made to Traditional IRAs and contributions made to Roth IRAs.
- Required Minimum Distributions (RMDs) from a traditional IRA must begin at age 73.
Empower Your Financial Future with an IRA
Anyone with earned income can open and contribute to an IRA, including those who have a 401(k) account through an employer. The key limitation is on the total amount that you can contribute to your retirement accounts in a single year.
The best IRA accounts offer the ability to invest in a wide range of financial products, including stocks, bonds, exchange-traded funds (ETFs), and mutual funds.
Self-directed IRAs (SDIRAs) permit investors to make all their investing decisions. SDIRAs offer access to a broader selection of investments, including real estate and commodities. Only the riskiest investments are off-limits.
Several types of IRAs exist, each with different rules regarding eligibility, taxation, and withdrawals. These types include:
- Traditional IRAs
- Roth IRAs
- Simplified Employee Pension (SEP) IRAs
- Savings Incentive Match Plan for Employees (SIMPLE) IRAs
Individual taxpayers can establish Traditional and Roth IRAs. Small business owners and self-employed individuals can set up SEP and SIMPLE IRAs.
An IRA must be opened with an institution that has received Internal Revenue Service (IRS) approval to offer these accounts. Choices include banks, brokerages, credit unions, and savings and loan associations.
IRAs are meant to be used to invest and maximize the growth of funds for retirement savings. An early withdrawal penalty of 10% may apply if you take money out before age 59½, in addition to taxes on the withdrawn amount.
However, there are notable exceptions to the penalty rule, such as withdrawals for educational expenses and first-time home purchases.
A Roth account is funded with post-tax money, so no further taxes are due when the money is withdrawn.
What Counts As Income?
You can only contribute to an IRA if you have earned income. Income from interest and dividends, Social Security benefits, or child support does not count.
Diverse IRA Options to Fit Your Needs
Traditional IRA
Contributions to Traditional IRAs are mostly tax-deductible, lowering your taxable income for the year. Your money grows tax-deferred. When you withdraw it after retiring, it is taxed at your ordinary income tax rate.
Contribution Limits for 2023 and 2024
For 2023, the maximum annual individual contribution to Traditional IRAs is $6,500. If you’re age 50 or older, you can also contribute a catch-up contribution of $1,000, for a total of $7,500. For 2024, the maximum annual individual contribution is $7,000, with the catch-up contribution remaining at $1,000 for those 50 and over.
If you don’t have a workplace retirement plan, your Traditional IRA contributions are fully deductible. However, if you or your spouse have a retirement plan at work, your modified adjusted gross income (MAGI) determines how much of your contributions can be deducted.
Roth IRA
Roth IRA contributions are not tax-deductible for the year you make them, but the distributions are tax-free. You contribute to a Roth IRA using after-tax dollars, and pay no taxes, even on investment gains.
Roth IRAs do not have required minimum distributions (RMDs). You can contribute to a Roth IRA as long as you have eligible earned income, no matter your age.
The income phase-out range for single filers is $138,000 to $153,000 for 2023 and $146,000 to $161,000 for 2024. For married couples, the phase-out range is $218,000 to $228,000 for 2023 and $230,000 to $240,000 for 2024.
SEP IRA
Self-employed individuals, such as independent contractors and small-business owners, can set up SEP IRAs. A SEP IRA follows the same tax rules for withdrawals as a Traditional IRA. For 2023, SEP IRA contributions are limited to 25% of compensation or $66,000, whichever is less. For 2024, the maximum allowed contribution is $69,000.
SIMPLE IRA
Intended for small businesses and self-employed individuals, SIMPLE IRAs follow the same tax rules for withdrawals as a Traditional IRA. The SIMPLE IRA employee contribution limit is $15,500 in 2023, with a catch-up limit of $3,500 for those age 50 or older. For 2024, the contribution limit is $16,000, with the catch-up amount staying at $3,500.
Required Minimum Distributions (RMDs)
Required Minimum Distributions (RMDs) are withdrawals required from Traditional IRA and 401(k) accounts starting at age 73, as of Jan. 1, 2023. The amount you must withdraw is based on your account size and life expectancy.
Failure to take the minimum triggers a tax penalty of 25% of the account balance. This penalty can be reduced to 10% if the corrective action is taken early.
Comparing IRA Options
| Type | Contribution Limit (2023) | Tax-Deductible Contributions | Tax-Free Distributions | Subject to RMDs | Who Can Establish |
|---|---|---|---|---|---|
| Traditional | $6,500 ($7,500 if 50 or older) | Yes | No | Yes | Individual taxpayers |
| Roth | $6,500 ($7,500 if 50 or older) | No | Yes | No | Individual taxpayers |
| SEP | $66,000 or 25% of income | For employers only | No | Yes | Small-businesses |
| SIMPLE | $15,500 ($19,000 if 50 or older) | Yes | No | Yes | Small-businesses |
Empower Your Retirement with an IRA
An IRA stands for
Related Terms: 401(k), retirement planning, investment accounts, tax-deferred growth.
References
- Internal Revenue Service. “What If I Withdraw Money From My IRA?”
- U.S. Securities and Exchange Commission. “Investor Alert: Self-Directed IRAs and the Risk of Fraud”.
- Internal Revenue Service. “IRA-Based Plans”.
- Internal Revenue Service. “Retirement Topics — Exceptions to Tax on Early Distributions”.
- Internal Revenue Service. “Earned Income and Earned Income Tax Credit (EITC) Tables”.
- Internal Revenue Service. “Topic No. 451, Individual Retirement Arrangements (IRAs)”.
- Internal Revenue Service. “Retirement Topics — IRA Contribution Limits”.
- Internal Revenue Service. “401(k) Limit Increases to $23,000 for 2024, IRA Limit Rises to $7,000”.
- Internal Revenue Service. “Retirement Topics - IRA Contribution Limits”.
- Internal Revenue Service. “Traditional and Roth IRAs”.
- Internal Revenue Service. “Amount of Roth IRA Contributions That You Can Make for 2023”.
- Internal Revenue Service. “Retirement Plan and IRA Required Minimum Distributions FAQs”.
- Internal Revenue Service. “SEP Plan FAQs”.
- Internal Revenue Service. “SEP Contribution Limits (Including Grandfathered SARSEPs)”.
- Internal Revenue Service. “COLA Increases for Dollar Limitations on Benefits and Contributions”.
- Internal Revenue Service. “SIMPLE IRA Plan”.
- Internal Revenue Service. “SIMPLE IRA Plan FAQs”.
- Internal Revenue Service. “Retirement Topics - SIMPLE IRA Contribution Limits”.
- Internal Revenue Service. “Rev. Rul. 2008-5”.
- Congress.gov. “SECURE 2.0 Act of 2022”, Pages 136 Stat. 5275, 5289.
- Internal Revenue Service. “Required Minimum Distribution Worksheets.”
- Internal Revenue Service. “Individual Retirement Arrangements (IRAs)”.
- Federal Deposit Insurance Corporation. “Are My Deposit Accounts Insured by the FDIC?”
- Internal Revenue Service. “Individual Retirement Arrangements (IRAs)”.
- Internal Revenue Service. “401(k) Plan Overview”.
