What is an IRA, and how does it work?

An individual retirement account (IRA) is a type of investment account that allows you to save for retirement independently of your employer. Because IRAs aren’t tied to your job (with a few exceptions that we’ll discuss shortly), they’re a good option for self-employed people. However, you can also open an IRA to supplement your savings in a workplace account, like a 401(k) or 403(b).

If you want to invest in an IRA but aren’t sure where to start, keep reading. We’ll explain all things IRAs, including the major types of IRAs, the basic rules, and how you can open one. We’ll also cover how IRAs stack up against 401(k)s and other retirement accounts.

Read more: Retirement planning: A step-by-step guide

An IRA is a tax-advantaged account that you open through a brokerage to save for retirement. Usually, you open an IRA on your own, but there are a few types of IRAs, like SEP IRAs and SIMPLE IRAs, that an employer can open on your behalf.

We’ll focus on the two main types of IRAs that individuals can open: traditional IRAs and Roth IRAs.

Traditional IRAs are funded with pre-tax money. You may be able to deduct contributions for tax purposes, depending on your income and whether you or your spouse participates in a workplace retirement plan.

Your money then grows on a tax-deferred basis. The tax bill comes due when you withdraw your money, as distributions are taxable as ordinary income. If you take distributions before age 59 ½, you’ll typically face a 10% early withdrawal penalty as well.

Learn more: Traditional vs Roth IRAs

Roth IRAs are funded with after-tax dollars, which means you don’t get a tax break in the year you contribute. As with a traditional IRA, your money grows on a tax-deferred basis. But if you wait until you’re 59 ½ and you’ve held the account for at least five years, distributions will be tax-free. You can also access your contributions (but not the earnings) without owing taxes or a penalty at any time.

There are a few other types of IRAs you may hear about, but they’ll all have either a traditional (pre-tax) structure or a Roth (post-tax) structure:

• Rollover IRA: A rollover IRA is an account that’s set up so you can transfer money from a past employer’s retirement plan without incurring taxes or a penalty.

• SEP IRA: SEP IRAs are designed for small business owners, the self-employed, or freelancers.

• SIMPLE IRA: Though most IRAs are opened independently of employers, SIMPLE IRAs are an exception. A SIMPLE IRA is a retirement account that businesses with 100 or fewer employees can set up to help workers save. Compared to other workplace plans, they’re usually easier and less costly to administer.

• Custodial IRA: A custodial IRA is an account that an adult (usually a parent or guardian) can set up and manage on behalf of a child who earns income. Once the child reaches the age of majority, which is 18 in most states, they’ll have full control of the funds.

• Spousal IRA: A spousal IRA is a traditional or Roth IRA that a working spouse can fund on behalf of a spouse with little or no annual income. The couple must be legally married and file a joint tax return to qualify.

• Inherited IRA: If you inherit an IRA or another retirement plan from a loved one, you can set up an inherited IRA to hold the funds. You won’t be allowed to make additional contributions, though, and you’ll need to deplete the account within 10 years of the original owner’s death.

IRAs have generous tax advantages, but you’ll need to follow several rules to reap the full benefits. Here are the basic requirements you should know about before you start investing.

You can contribute to both types of IRAs regardless of age, but you’ll need to have taxable compensation, also known as earned income, for the year in which you contribute. The IRS defines earned income as basically any income you earn from working, such as a salary, hourly wages, tips, commission, or self-employment income.

Anyone with taxable compensation can contribute to a traditional IRA regardless of income. However, you may not be able to deduct your contribution if you or your spouse has access to a workplace retirement plan and your income exceeds certain thresholds.

Roth IRAs have income limits. In 2025, you can make the full contribution if you’re single with a modified gross adjusted income (MAGI) of less than $150,000, or married filing jointly with a combined income of less than $236,000. Those with higher incomes may be able to contribute a reduced amount. However, single filers with incomes above $165,000 and joint filers earning more than $246,000 aren’t eligible to directly fund a Roth IRA in 2025.

In 2026, you can make a full IRA contribution if you’re single with a MAGI of less than $153,000, or married filing jointly with a combined MAGI of less than $242,000. You can make partial Roth contributions if you’re single and earn between $153,000 and $168,000, or married and earn a combined income between $242,000 and $252,000. No contributions are allowed if you’re single and your MAGI is higher than $168,000 or you’re married, filing jointly with a combined MAGI of more than $252,000.

The IRS sets annual IRA contribution limits that are adjusted annually to keep up with inflation. In 2025, you can contribute up to $7,000 to a traditional IRA, Roth IRA, or a combination of the two. If you’re 50 or older, you can deposit an additional $1,000 catch-up contribution, bringing your limit to $8,000. In 2026, the contribution limit is $7,500, or $8,600 after your 50th birthday.

Note that contributions can’t exceed your earned income for the year. For example, if you earn $5,000, your maximum IRA contribution for the year is $5,000.

A traditional IRA is funded with pre-tax money, so you’ll pay income tax on any withdrawals. If you’re taking a distribution before age 59 ½, a 10% early withdrawal penalty will typically apply, though there are a few exceptions. For example, if you become permanently disabled or you’re taking up to $10,000 for a qualified first-time home buyer purchase, you may be able to avoid the penalty (but not the taxes).

Learn more: What is the retirement age for Social Security, 401(k), and IRA withdrawals?

Contributing to a Roth IRA won’t lower your taxable income, but there are more ways to avoid taxes or a penalty on withdrawals. As noted, you can withdraw your contributions at any time without taxes or penalties. You can withdraw earnings without taxes or penalties after you’re 59 ½ and the account has been open for at least five years. As with a traditional IRA, you may be able to avoid the 10% penalty on early withdrawals in some circumstances.

Traditional IRAs have mandatory withdrawals called required minimum distributions (RMDs) that begin when you turn 73. The RMD increases to 75 in 2033. RMDs are never required for Roth IRAs during the original account holder’s lifetime.

IRAs and 401(k)s are both tax-advantaged retirement accounts that can have both pre-tax and Roth tax structures. However, an IRA is an account you open on your own, while a 401(k) is an account you open through your employer. Here are a few other key distinctions between 401(k)s vs. IRAs you’ll want to know.

Learn more: How a 401(k) match works and why you should seek it out

Note that you don’t have to choose between a 401(k) or IRA, provided that you work for a company that sponsors a 401(k). You are allowed to have both accounts, and you can make 401(k) contributions and traditional IRA contributions in the same year. The only drawback is that your traditional IRA contributions may not be tax deductible. Or, if you meet the Roth IRA income requirements, you can contribute to a 401(k) and a Roth IRA in the same year.

There’s no one-size-fits-all approach to choosing an IRA, but here are some factors to consider when you compare and choose a provider:

• Costs: Look at all costs associated with the account, including account fees, subscription costs, trading fees, and assets under management (AUM) fees. Also consider any minimum balance and/or opening deposit requirements.

• Investment choices: Be sure you know what you can invest your IRA in before you open your account. Many top IRA providers let you invest in a broad range of stocks, bonds, mutual funds, exchange-traded funds (ETFs), and fixed-income products, like certificates of deposit (CDs).

• Advisor access: Many providers offer robo-advisors to help you automate your investments, or they provide access to human financial advisors. Think about how much guidance you’ll want when you select an IRA.

• User experience and features: Compare each platform’s website and mobile app to determine if it’s relatively easy to use. Also, look at how you can access customer support and whether you’ll have access to research and trading tools that can help you make informed decisions.

Learn more: Gold IRA: Benefits, risks, and how it differs from a traditional IRA

Opening an IRA is straightforward. Most of the top IRA providers make it easy to open an account online in just a few minutes. If you’re ready to start investing for retirement, follow these steps:

1. Decide whether you want a Roth or traditional IRA: For most people, this decision boils down to whether you’d prefer to get an upfront tax break (with a traditional IRA) or if you prefer the tax break in retirement (with a Roth IRA). But you’ll also need to consider whether you’re eligible to deduct your traditional IRA contributions, as well as your eligibility for a Roth IRA.

2. Choose a provider: Look for a provider that offers low fees, an easy-to-use platform, and the investment options you want. If you don’t have much money to invest, also consider the provider’s minimum opening deposit.

3. Open the account: You’ll need to provide a few pieces of personal information, like your name, date of birth, Social Security number, and employer.

4. Fund your account: Once you’ve set up your IRA, you’ll need to fund the account to start investing. Your provider will provide the information you need to transfer money to your IRA.

5. Select your investments: Now it’s time to invest your money. If you’re new to investing and you’re not sure where to start, a robo-advisor can automatically invest money for you, assuming your provider offers one. Otherwise, consider an exchange-traded fund (ETF) or a mutual fund that tracks all of the U.S. stock market, like a total stock market fund, or a broad swath of it, like an S&P 500 fund. These funds are diversified with different types of stocks, which is less risky than investing in a few individual stocks. You will also want to hold some cash or government bonds alongside your stock funds as another layer of diversification.

If you have a 401(k) or 403(b) from a past employer, rolling it over into an IRA can be a smart move. IRAs tend to have lower fees and more investment options than 401(k)s. Plus, keeping your retirement money in a single account makes things easier to manage and helps you avoid leaving forgotten 401(k) money on the table.

You must follow some IRA rules to avoid an early withdrawal penalty on the rollover. You’ll need to choose an IRA that matches the tax structure (traditional or Roth) of the account you’re rolling over and you must complete the rollover within 60 days.

Initiate the rollover by contacting your former employer’s plan administrator. You can do a direct or indirect rollover – choose direct whenever possible. For a direct rollover, the plan administrator sends the balance directly to your IRA provider. If you opt for an indirect rollover, the plan’s sponsor will cut the check directly to you and withhold 20% for federal taxes. If you don’t deposit those funds to an IRA within 60 days, you could pay more taxes and a 10% early withdrawal penalty if you’re younger than 59 ½.

You have until Tax Day to contribute to an IRA for any tax year. In other words, you can make 2025 contributions until April 15, 2026.

The IRS prohibits IRA loans. When you withdraw money from a traditional IRA, you have 60 days to re-deposit the money in your IRA or another retirement account. Providers are generally required to withhold 10% of your withdrawal for federal taxes. So if you need $10,000, you’d need to take out $11,000.

If you don’t deposit the money in a retirement account within 60 days, it’s treated as a distribution. You’ll owe any applicable taxes, and a 10% penalty may apply if you’re younger than 59 ½.

The goal of investing in an IRA is for your money to grow on a tax-deferred basis, but growth ultimately depends on the performance of your investments.

Suppose you invested your IRA money in an S&P 500 index fund for 30 years. The S&P 500, which represents about 80% of the U.S. stock market by value, has historically produced average annual returns of about 10%. If you invested $5,000 a year and earned 10% annual returns, you’d have nearly $910,000 after 30 years – even though you only contributed $150,000 total.

Tim Manni edited this article.