What Is an IRA?

Retirement might feel far away, but the data shows that we’ll need more money than ever saved up to retire. Though there are several ways to save for retirement, one of the most common is the IRA. So what exactly is an IRA? And what do they do? We’re here to answer all your questions.

What even is an IRA?

IRA stands for individual retirement account. It’s a long-term savings account that people who work for a living can use to save for retirement, while enjoying some tax benefits. While anyone can open an IRA, it’s most often used by people who are self-employed and, therefore, don’t have access to accounts like 401(k)s. You can open an IRA through banks, investment companies, or brokers.

When you open an IRA, you’re actually investing long-term in a portfolio of several products, like stocks, bonds, ETFs, and mutual funds. Self-directed IRAs allow you to choose all your investments, while traditional IRAs offer pre-selected portfolios.

Anyone can open an IRA, even someone who already has a 401(k). You can also contribute as much as you want to your IRA until you hit the yearly cap.

Four Types of IRA

There are four types of IRAs, each with varying rules about who can open them, how they’re taxed, and what you can withdraw from them. The four types of IRA are:

  • Traditional IRAs. Most of the time, contributions to these IRAs are tax deductible. Your money grows in the account with taxes deferred, meaning that it will not be taxed until you withdraw the money after retiring. In 2024, the limit you can contribute to a traditional IRA is $7,000. Unless you’re over 50, in which case you can contribute $8,000. Once you reach a certain age, though, you have to take a certain amount out of your IRA every year.
  • Roth IRAs. Contributions to a Roth IRA are not tax deductible. However, you don’t have to pay taxes on your investment gains. You can contribute to a Roth IRA for as long as you’re working and, unlike a traditional IRA, you’re not required to take money out unless you’ve stopped earning an income. The yearly contribution limits for a Roth IRA are the same as a traditional IRA with a catch: if you earn too much money, you may not be allowed to contribute as much.
  • SEP IRAs. SEP IRAs are available to people who are self-employed, like freelancers, independent contractors, and small business owners. SEP IRAs have the same withdrawal rules as traditional IRAs. However, they have much higher caps for contribution (up to 25% of your income or $66,000, whichever is less). Small business owners often set up SEP IRAs for their employees, but employees are not allowed to contribute additional funds to their accounts.
  • SIMPLE IRAs. The SIMPLE IRA is also made for small business owners and people who are self-employed. The difference is that with the SIMPLE IRA, employees are allowed to make contributions to their accounts, along with any contributions made by their employer. Like the other IRAs, this one has a yearly cap: $16,000 in 2024 (or $19,500 if you’re over 50).

So Do I Need an IRA?

Not necessarily, especially if you have another retirement savings plan at work. However, for those who do a lot of freelance or contract work, an IRA can be a great way to ensure that you’re saving for your future. If you have additional money to set aside, even with a 401(k), an IRA can help give you some padding for a retirement you can be excited about.