Understanding Individual Retirement Accounts

Summary

• An individual retirement account, or IRA, can provide another way to save for retirement, whether or not you have a retirement plan through work.
• Traditional and Roth IRAs offer different tax treatment, so the timing of taxes is one of the main differences to consider.
• Eligibility, contribution limits and potential tax deductions depend on factors such as earned income, modified adjusted gross income and workplace retirement plan coverage.
• IRA withdrawal rules differ by account type, and early withdrawals may trigger taxes or penalties unless an exception applies.
• An IRA can offer a broad range of investment choices, giving you flexibility in how you build toward your retirement goals.

An individual retirement account can help you build retirement savings outside of an employer-sponsored plan. If you do not have a retirement plan at work—or you want another way to save—an IRA can give you more control over how and where your money is invested.

Understanding the differences between IRA types can help you decide how each option may fit into your broader retirement goals.

How IRAs Work

An IRA is an account designed for retirement investing. You can generally open one through a financial institution, investment company or brokerage.

Depending on the account and provider, investments may be managed for you or you may have more direct control over the assets held in the account. That flexibility can make an IRA useful for people who want additional choices beyond those available in a workplace retirement plan.

The two main types are traditional and Roth IRAs. Both are designed to support long-term retirement saving, but their tax treatment is different.

Traditional vs. Roth IRAs

The biggest difference between traditional and Roth IRAs is when taxes generally apply.

With a Roth IRA, contributions are made with money that has already been taxed. Qualified withdrawals in retirement can then be tax-free. Roth IRAs also do not require the original account owner to take required minimum distributions during their lifetime.

With a traditional IRA, eligible contributions may be tax-deductible in the year they are made. Taxes are generally deferred until money is withdrawn. Whether a contribution is deductible depends on factors that can include your income and whether you or your spouse are covered by a retirement plan at work.

Your modified adjusted gross income, or MAGI, also affects certain IRA eligibility and deduction rules. Because income thresholds and contribution limits can change, review current IRS guidance before making contribution or tax decisions.

What Are the Advantages of an IRA?

An IRA can give you more control over your retirement savings and investments. Depending on the provider, you may be able to choose from a broad range of investments, including certificates of deposit, Treasury securities, savings bonds, stocks and mutual funds.

Traditional and Roth IRAs also provide different tax advantages. A traditional IRA may provide a tax deduction for eligible contributions, while a Roth IRA may provide tax-free qualified withdrawals in retirement.

The right approach depends on your circumstances, including your income, tax situation, retirement timeline and other savings.

Eligibility and Contributions

Earned income is central to IRA contribution eligibility. Traditional and Roth IRAs also have annual contribution limits, and Roth IRA eligibility is subject to income limits.

If you have both a traditional IRA and a Roth IRA, the annual contribution limit generally applies to your combined contributions across both account types rather than separately to each account.

Because these limits and income thresholds can change from year to year, check current IRS rules before contributing.

Spousal IRAs

A married couple may be able to contribute to an IRA for a spouse who does not have earned income when the couple files a joint tax return and meets applicable requirements.

The account belongs to the non-working spouse, which can help each spouse build retirement savings in their own name. Each spouse has a separate IRA, and applicable annual contribution limits still apply to each account.

Understand Withdrawal Rules

Withdrawal rules depend on the type of IRA and whether the money being withdrawn represents contributions or earnings.

Roth IRA contributions have already been taxed, so those contributions can generally be withdrawn without the same tax and early-withdrawal consequences that may apply to earnings. Withdrawals of Roth IRA earnings can be subject to taxes and an additional penalty when requirements for a qualified distribution are not met.

Traditional IRA withdrawals are generally taxable. Taking money from a traditional IRA before age 59½ may also result in an additional early-withdrawal penalty unless an exception applies.

Traditional IRAs are also subject to required minimum distribution rules later in life. Roth IRAs do not require minimum distributions from the original owner during that person’s lifetime.

There are exceptions to some early-withdrawal penalties. Because the rules can be detailed and individual circumstances matter, review current IRS guidance or speak with a qualified tax professional before taking an early distribution.

Choosing Investments for an IRA

An IRA may offer more investment choices than a typical workplace retirement plan. Depending on the provider and account, available options may include CDs, Treasury securities, savings bonds, stocks and mutual funds.

Having more choices also means deciding how involved you want to be. Some people prefer a more hands-on approach, while others may choose professionally managed options.

As you compare choices, consider how each investment fits your time horizon, comfort with risk and overall retirement goals. A retirement calculator can also help you think through how much you may need to save to support your desired retirement lifestyle.

Keep the Bigger Retirement Picture in View

An IRA can be one part of a broader retirement strategy. Understanding the differences between traditional and Roth accounts, contribution rules, withdrawal requirements and investment choices can help you ask better questions and make decisions that fit your circumstances.

If you want help connecting IRA decisions with your broader financial plan, consider speaking with a qualified financial or tax professional and reviewing additional financial wellness resources before taking your next step.