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An individual retirement account, or IRA, lets you maximize retirement savings by saving money on your pre-retirement tax bills. Depending on type, an IRA may allow you to contribute pre-tax dollars to your retirement fund or withdraw money tax-free in retirement. Meanwhile, your money grows tax-deferred or tax-free while it's in your account.
What Is an Individual Retirement Account (IRA)?
An IRA is a tax-advantaged account that helps you save toward retirement. Unlike employer-based plans like 401(k)s and 403(b)s, IRAs aren't tied to your workplace or paycheck: They're accounts you open and fund yourself. As long as you have income, you can contribute to an IRA—whether or not you also contribute to a retirement plan at work.
Reduce Taxable Income With a Traditional IRA
Contributions to a traditional IRA are excluded from your taxable income. If you contribute $6,500 to a traditional IRA in 2023, you can deduct $6,500 on your federal taxes for the year. Tax savings serve as an incentive to save; they also give you a few extra dollars to tuck away. You don't pay taxes on interest, dividends or capital gains while your money grows in your traditional IRA.
You will, however, pay regular income taxes on any money you withdraw. With a few exceptions, early withdrawals made before age 59½ are also subject to a 10% penalty tax. You must start taking required minimum distributions from your account starting at age 72 or 73.
Grow Funds and Withdraw Tax-Free With a Roth IRA
A Roth IRA is funded with after-tax dollars, so you can't deduct your contributions on your federal taxes. However, your money grows tax-free as long as it stays in your Roth account. When you take qualified distributions in retirement, these are also tax-free.
Because you've already paid taxes on your Roth contributions, you can withdraw them anytime without penalty, though you may pay an early withdrawal tax if you take out earnings or gains before age 59½. Roth IRAs do not have required minimum distributions.
Types of IRAs
The main distinction among IRAs is between traditional and Roth accounts. However, there are different types of IRAs to suit different needs. Here's a quick rundown.
- Traditional IRAs allow you to deduct contributions on your federal tax return. You pay income taxes on any money you withdraw.
- Roth IRAs are funded with after-tax dollars, but money grows tax-free and is not taxed when you make a qualified withdrawal.
- Rollover IRAs are special-purpose accounts you can use to transfer the contents of 401(k) and other employer-sponsored retirement plans when you leave a job. Rollover IRAs may also be used to consolidate retirement accounts, including IRAs, into a single account so you have fewer accounts to track and greater control over how funds are invested.
- Spousal IRAs allow non-working spouses to contribute to their own tax-advantaged retirement accounts based on their spouse's taxable income.
- SEP and SIMPLE IRAs are for businesses and self-employed people. They allow business owners to contribute to employees' retirement and their own, and have more generous contribution limits than regular IRAs.
IRA Contribution Limits
The IRS limits the amount you can contribute to both traditional and Roth IRAs. Contribution limits may adjust year to year based on the cost of living. For 2023, the limit on combined contributions to all of your IRAs is $6,500—$7,500 if you're age 50 or older. Your IRA contributions also can't exceed your taxable compensation for the year.
Employers can make a SEP-IRA contribution of up to 25% of an employee's compensation (not to exceed $66,000) in 2023. The 2023 contribution limit for SIMPLE IRA plans is $15,500.
IRA Deduction Limits
Deducting the contributions you make to a traditional IRA is a key tax benefit. But, if you're covered by a retirement plan at work, you may be limited in how much you can deduct on your tax return. The chart below shows how your modified adjusted gross income affects the amount you can deduct for traditional IRA contributions. If you are married but file separately and did not live with your spouse at any time during the year, check the IRA deduction limits for single filers.
| 2023 IRA Deduction Limits if You're Covered by a Retirement Plan at Work | ||
|---|---|---|
| Filing Status | 2023 Modified Adjusted Gross Income | Amount You Can Contribute |
| Single or head of household | $73,000 or less | Full deduction up to the maximum contribution |
| More than $73,000 but less than $83,000 | Partial deduction | |
| $83,000 or more | Zero | |
| Married filing jointly or qualified widow(er) | $116,000 or less | Full deduction up to the maximum |
| More than $116,000 but less than $136,000 | Partial deduction | |
| More than $136,000 | Zero | |
| Married filing separately | Less than $10,000 | Partial deduction |
| $10,000 or more | Zero |
Source: IRS
Roth IRA Income Limits
You may also encounter limitations when contributing to a Roth IRA. Single filers with modified adjusted gross incomes of $138,000 or more ($218,000 for married filers) may not be eligible to contribute the full amount to a Roth IRA. See how IRS phase-out ranges work in the table below.
| 2023 Roth IRA Contribution Limits | ||
|---|---|---|
| Filing Status | 2023 Modified Adjusted Gross Income | Amount You Can Contribute |
| Single, head of household or married filing separately (and you did not live with your spouse at any time during the year) | Less than $138,000 | Up to the maximum |
| $138,000 to $152,999 | A reduced amount | |
| $153,000 or more | Zero | |
| Married filing jointly or qualified widow(er) | Less than $218,000 | Up to the maximum |
| $218,000 to $227,999 | A reduced amount | |
| $228,000 or more | Zero | |
| Married filing separately | Less than $10,000 | A reduced amount |
| $10,000 or more | Zero |
Source: IRS
How to Open an IRA
Ready to open an IRA? Follow these easy steps to set yourself up for savings.
- Choose a traditional or Roth IRA. Broadly speaking, you'll either see tax savings now (with a traditional IRA) or tax savings in the future (with a Roth).
- Find the right provider. Most brokerage firms, banks and credit unions offer IRAs. In addition to selecting from a wide range of financial institutions, you'll find an array of bank account and investment options (exchange-traded funds, mutual funds, stocks, bonds or savings accounts, for example). You can also choose between self-managed accounts, robo-advisors or professional advisors to help you find and maintain the right portfolio balance.
- Fund your account. You can always deposit a lump sum, but you may also be able to open an account with a small balance and add to it with automatic monthly deposits.
FAQs
Still have questions about IRAs? Here are answers to a few frequently asked questions.
Employer-based 401(k)s have a few advantages worth considering. First, IRS contribution limits are higher on 401(k), 403(b) and other employer-based plans: For 2023, contribution limits are $22,500 with an additional catch-up contribution of $7,500 if you're 50 or older. Some employers provide matching funds for your 401(k) contributions. If that's the case, you may get an immediate return on your investment (in the form of matching dollars), which can help grow your savings fast.
IRAs have their advantages too. Anyone with taxable income can open and fund an IRA. There's no vesting period. You choose your own brokerage, bank, mutual fund company or advisor, and you don't have to make a change if you decide to change jobs.
If your IRA funds are invested in stocks, mutual funds, exchange-traded funds and many other types of investments, the value of your account can fluctuate. In a good market, you may see your account value increase significantly; in a down market, you may lose money.
The key is to stay invested as you monitor your long-term savings and investment goals. Working with a financial advisor to manage risk, diversify your investments and keep up with trends may help to minimize losses—and allay your fears. You may also want to consider keeping some of your IRA funds in a more stable, predictable investment like an IRA certificate of deposit (CD), which pays fixed interest and may be insured by the Federal Deposit Insurance Corp. (FDIC) or National Credit Union Administration (NCUA).
If you have money you'd like to invest for retirement but you've maxed out your 401(k) and IRA contributions—or you want flexibility to be able to use the money before you reach retirement age—consider putting your money in a taxable investment account (if you're keen on investing) or a high-yield savings account (if you're most concerned about liquidity).
If you have a high-deductible health plan, you may be able to contribute to a health savings account (HSA), which offers a tax deduction on contributions and tax-free withdrawals when you spend on qualifying health care expenses.
The Bottom Line
IRAs can make saving and investing for retirement easier. They are widely available and represent a broad range of investment options. Best of all, tax advantages let you maximize your contributions and capitalize on growth as you move toward retirement. Whether they're a primary means of saving for retirement or just one of many tools in your toolkit, IRAs are an easy and accessible way to make the most of your retirement planning.