Individual Retirement Accounts (IRAs): A Guide

An individual retirement account (IRA)

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Investing in an IRA allows your money to grow and compound, says certified financial planner Matt Aaron, founder of Washington, D.C.-based Lux Wealth Planning, an affiliate of Northwestern Mutual. You can invest in stocks, bonds and other assets. How your account balance grows over time depends on how you invest and how much you contribute to the IRA. (See how to invest your IRA for simple investment strategies.)

IRAs have annual contribution limits. Generally, you (or your spouse) must have earned income to contribute to an IRA. There are also withdrawal rules: You may face a 10% penalty and a tax bill if you withdraw money before age 59 1/2, unless you qualify for an exception

What are the types of IRAs?

Traditional IRA

Contributions to traditional IRAs are often tax-deductible. For example, contributing $3,000 to a traditional IRA could reduce the amount of your taxable income by $3,000. However, withdrawals from traditional IRAs in retirement are taxable as ordinary income. The contribution limit for traditional IRAs in 2022 is $6,000 per year. People 50 and older can contribute up to $7,000 per year

If you’re married and you or your spouse has a retirement plan at work, the amount of your traditional IRA contribution that you can deduct is reduced, and eventually eliminated altogether, once you hit a certain income. You can still make contributions, but they won’t be tax-deductible. If you and your spouse don’t have retirement plans at work, then you can deduct your IRA contribution no matter how much your income.

Traditional IRA deduction limits in 2022

How much of your traditional IRA contributions can you deduct from your taxes? These income limits apply only if you (or your spouse) have a retirement plan at work.

Single or head of household (and covered by retirement plan at work)

More than $68,000 but less than $78,000

Married filing jointly (and covered by retirement plan at work)

More than $109,000 but less than $129,000

Married filing jointly (spouse covered by retirement plan at work)

More than $204,000 but less than $214,000

Married filing separately (you or spouse covered by retirement plan at work)

Generally, you can take distributions from a traditional IRA starting at age 59 1/2. If you take money out before then, you may have to pay a 10% penalty (there are some exceptions). You must start taking required minimum distributions when you reach age 72.

Roth IRA

Contributions to Roth IRAs are not tax-deductible, but withdrawals from Roth IRAs are tax-free and there are no taxes on investment gains. It’s an attractive option for investors who have a long time before they retire, Aaron says.

“The question is, do you want to pay your taxes now or later? For me, I’d rather pay taxes now,” he says.

Roth IRAs can help you  combat inflation, Aaron says, because money loses value over time. He says he thinks of a Roth IRA as paying taxes on the seed vs. paying taxes on the harvest.

“I don’t have the magic ball and I can never say I know what’s going to happen in the future, but if taxes go up, and you’re taking that money out in the future, you get to potentially minimize the taxes you pay.”

In 2022, the annual Roth IRA contribution limit is $6,000 ($7,000 if 50 or older) for modified adjusted gross incomes below $144,000 for single filers and head of household, or $214,000 for married people filing jointly.

Do you qualify for a Roth?

Maximum annual contribution

Single, head of household or married filing separately (if you didn’t live with spouse during year)

$6,000 ($7,000 if 50 or older)

Married filing jointly or qualifying widow(er)

$6,000 ($7,000 if 50 or older)

Married filing separately (if you lived with spouse at any time during year)

SEP IRA

Generally, SEP IRAs are IRAs for self-employed people or small-business owners with few or no employees. Similar to traditional IRAs, the contributions are tax-deductible. Investments grow tax-deferred until retirement when distributions are taxed as income.

In 2022, contributions are limited to 25% of compensation or $61,000, whichever is less. There’s no catch-up contribution at age 50+ for SEP IRAs, and SEP IRAs require minimum distributions beginning at age 72. SEP IRAs require proportional contributions for each eligible employee if business owners contribute for themselves.

SIMPLE IRA

SIMPLE IRAs (Savings Incentive Match Plan for Employees Individual Retirement Accounts) are for small businesses with fewer than 100 employees. Similar to traditional IRAs, the contributions are tax-deductible. Investments grow tax-deferred until retirement when distributions are taxed as income. Employee contribution limits for a SIMPLE IRA in 2022 are $14,000 per year for those under age 50. People age 50 and older can make an additional $3,000 catch-up contribution. Employer contributions are mandatory.

Rollover IRA

A rollover IRA is an IRA you open when you transfer eligible assets from an employer sponsored plan, such as a 401(k), into an IRA.

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“The main benefit of an IRA is your ability to have more investment options and choices,” says Aaron, the CFP.

A 401(k) or pension may not provide enough retirement income. Putting the maximum contribution amount in an IRA can help you prepare for retirement, save on taxes, and access investment options your workplace retirement plan might not offer.

“There is a lot more flexibility in what you can do,” Aaron says.

The benefits of an IRA and Roth IRA

Is it better to have a 401(k) or IRA?

If you don’t get an employer match, if you plan to max out your 401(k), or if your 401(k) has narrow investment options or high fees, it might be a good idea to invest primarily in an IRA.

The big difference between an IRA and a 401(k) is that employers offer 401(k)s, while you would open an IRA yourself through a broker or bank. IRAs typically offer more investment options; 401(k)s allow higher annual contributions.

If you have an old 401(k), you can also move that money into a rollover IRA. A benefit of a rollover IRA is that when done correctly, the money keeps its tax-deferred status and doesn’t trigger taxes or early withdrawal penalties.

Two popular ways to get an IRA are through brokers and robo-advisors.

  • Brokers: If you want to choose investments for yourself, an online broker can be a good way to go. Review our best IRA accounts to compare.

  • Robo-advisors: If you want help managing your retirement account, consider a robo-advisor — a service that selects low-cost and risk-appropriate investments for you. See our list of best robo-advisors for help choosing the right one for you.

See our guide to opening an IRA for more information on moving money into your account.

IHowBlog editor Pamela de la Fuente contributed to this report.

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