What is an IRA? An Individual Retirement Arrangement

An IRA, or Individual Retirement Arrangement (sometimes called an Individual Retirement Account), is a personal savings plan that gives you tax advantages for setting money aside for retirement.

Unlike a 401(k), which is tied to your employer, an IRA is an account you open and manage on your own through a bank, brokerage firm, or other financial institution. This gives you much more control and a wider range of investment choices.

How is an IRA Different from a 401(k)?

• Sponsor: 401(k)s are sponsored by employers. IRAs are opened by individuals.
• Investment Choices: 401(k)s typically offer a limited menu of investment options (mutual funds). IRAs, especially brokerage IRAs, allow you to invest in almost anything: individual stocks, bonds, mutual funds, ETFs, and more.
• Contribution Limits: The annual contribution limit for IRAs is generally much lower than the limit for 401(k)s.
• Employer Match: Employers do not match IRA contributions (though some small businesses offer SEP-IRAs or SIMPLE IRAs, which are different).
• Eligibility: Anyone with earned income (or a spouse with earned income) can contribute to an IRA, regardless of whether their employer offers a 401(k).

It’s common and often recommended to have both a 401(k) (especially to get an employer match) and an IRA (for more investment options and tax flexibility).

The Two Main Types of IRAs: Traditional vs. Roth

The biggest difference between the two main types of IRAs lies in how they are taxed.

Traditional IRA

• Tax Deduction Now (Maybe): Depending on your income and whether you (or your spouse) have a workplace retirement plan, your contributions may be tax-deductible. This lowers your taxable income *today*.
• Tax-Deferred Growth: Your investments grow over time without being taxed each year.
• Taxed Later: When you withdraw money in retirement (after age 59½), the withdrawals are taxed as ordinary income.
• Required Minimum Distributions (RMDs): You are required to start taking withdrawals at age 73 (as of 2023).

Roth IRA

• No Tax Deduction Now: Contributions are made with *after-tax* dollars. You pay taxes on the money today.
• Tax-Free Growth: Your investments grow completely tax-free.
• Tax-Free Later: Qualified withdrawals in retirement (after age 59½ and having the account for at least 5 years) are *100% tax-free*.
• No RMDs: There are no Required Minimum Distributions for the original owner.
• Withdraw Contributions: You can withdraw your *contributions* (not earnings) from a Roth IRA at any time, for any reason, tax-free and penalty-free.

Note: There are income limits on who can *contribute* to a Roth IRA, and on who can *deduct* contributions to a Traditional IRA. See our detailed comparison of Roth vs. Traditional IRAs.

Who Should Open an IRA?

An IRA is a great tool for almost everyone saving for retirement:

• Employees whose jobs don’t offer a 401(k).
• Freelancers, gig workers, and self-employed individuals.
• Employees who already contribute enough to their 401(k) to get the full employer match and want to save even more.
• Anyone who wants more investment choices than their 401(k) provides.

Opening an IRA is a simple process at any major online brokerage and is a fundamental step in taking control of your retirement savings.