An Individual Retirement Account (IRA) is a tax-advantaged way to save for retirement in the United States. The two most common types are the Traditional IRA and the Roth IRA. The main difference is when you pay taxes. This article is about U.S. rules. Other countries have similar accounts with different names and rules.
How a Traditional IRA works
With a Traditional IRA, you may be able to deduct your contributions from your taxable income in the year you contribute, depending on your income and whether you or your spouse have a workplace retirement plan. Your money grows tax-deferred, and you pay ordinary income tax when you withdraw it in retirement.
How a Roth IRA works
With a Roth IRA, you contribute money you have already paid tax on, so there is no tax deduction now. In exchange, qualified withdrawals in retirement, including the growth, are generally tax-free. Eligibility to contribute directly to a Roth IRA phases out at higher incomes.
| Feature | Traditional IRA | Roth IRA |
|---|---|---|
| Tax break | Possible deduction now | Tax-free qualified withdrawals later |
| Contributions | May be tax-deductible | Made with after-tax money |
| Withdrawals in retirement | Taxed as ordinary income | Generally tax-free if qualified |
| Required withdrawals | Required minimum distributions start at a set age | None for the original owner |
| Income limits | For the deduction, in some cases | For direct contributions |
Which one might suit you?
- A Roth may appeal if you expect to be in a higher tax bracket in retirement, or if you want tax-free income and flexibility later.
- A Traditional IRA may appeal if you expect a lower tax bracket in retirement and want a tax deduction today.
- Many people split their savings between both to diversify their tax situation.
Withdrawal rules to know
Generally, withdrawing earnings before age 59 and a half can trigger income tax and a 10% early withdrawal penalty, with some exceptions. With a Roth IRA, the money you contributed (not the earnings) can typically be withdrawn at any time without tax or penalty. Rules are detailed, so check current IRS guidance.
Contribution limits
The IRS sets an annual contribution limit, which changes from time to time and is higher for people aged 50 and over. Because limits are updated regularly, always check the current figure on the IRS website before contributing. The limit applies across all your IRAs combined, not per account.
Before you open an IRA
- If your employer offers a retirement plan with a matching contribution, contribute enough to get the full match first. It is effectively free money.
- Build an emergency fund so you are not forced to withdraw early.
- Choose a low-cost provider and diversified investments inside the account.
- Set up automatic monthly contributions.
- Consider speaking with a tax professional about your situation.
IRA vs 401(k): how they fit together
Many U.S. employers offer a 401(k), a workplace retirement plan with higher annual contribution limits than an IRA. Some employers also add a matching contribution, which is one of the best guaranteed returns available. Many plans offer both traditional and Roth options. A common order of priorities is to contribute enough to get the full employer match, then consider an IRA for lower fees and more investment choices, then return to the 401(k) to save more if you can. Your situation may differ, so consider getting advice from a tax professional or fiduciary financial planner.
Frequently asked questions
Can I have both a Roth and a Traditional IRA?
Yes, but total contributions across both are limited to the annual limit.
Is an IRA an investment?
No, it is an account type. You choose investments such as funds or stocks to hold inside it.
What if I do not live in the US?
Look for the retirement savings accounts in your own country, and check local tax rules.
This article is for general educational purposes only and is not financial, investment, tax or legal advice. Rules, rates and figures change and differ by country, so check current information and consider speaking with a licensed professional before making decisions.