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What is an IRA? 4 types, Pros and cons

These tax-advantaged retirement accounts can help you save for retirement, but each type serves a different purpose. Learn about IRAs and how to open one of these valuable retirement accounts.

An individual retirement account (IRA) can be a powerful ally on the path to building your retirement nest egg. But not all IRAs are made equal. The right IRA for your investment needs will depend on your income trajectory and savings goals.

What is an IRA?

An IRA is an investment account designed to help you save for retirement, and you can use your account to invest in a range of assets.

IRAs come in a variety of types, with the traditional IRA and Roth IRA being the two most popular. Other IRA types include savings incentive match plan for employees (SIMPLE) IRAs and simplified employee pension (SEP) IRAs.

Each account is bound by a unique set of rules, like how much you’re allowed to contribute annually and how account deposits and distributions are taxed.

How do IRAs work?

IRAs are a common investment account and can be found at most banks, credit unions and online brokers. Financial institutions that hold your IRA’s investments are known as IRA custodians. While the law permits any investment inside an IRA except life insurance and collectibles, it’s ultimately up to the IRA custodian as to what assets they offer their customers.(1) Common investment options include stocks, bonds, exchange-traded funds (ETFs) and mutual funds. Some IRA custodians will also let you invest in alternative assets such as cryptocurrency and real estate.

The Internal Revenue Service (IRS) determines how much money you can deposit each year and when you can withdraw that money. In general, withdrawing IRA money before the age of 59.5 will trigger a 10% early-withdrawal penalty in addition to regular taxes on the distribution.

IRAs offer tax-advantages depending on the type of account you open. For instance, contributions to a traditional IRA are tax-deductible, while qualified distributions from a Roth IRA are tax-free.

Important contribution changes for 2024

The IRA contribution limit for 2024 increased to $7,000 ($8,000 if you’re age 50 or older). This is the amount you can contribute to all your traditional and Roth IRAs in total. Roth IRA income limits may reduce your allowable contribution amounts to a Roth IRA.

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4 types of IRAs

Individual retirement accounts come in four main types. Learn more about each IRA type to understand which account can serve you best.

1. Traditional IRA

Contributions made to traditional IRAs are typically tax-deductible. This means if you deposit $1,000 into your traditional IRA, your taxable income for the year drops by $1,000. The downside? All withdrawals made from a traditional IRA are subject to tax. And if you make a withdrawal from your traditional IRA before the age of 59.5, you’ll pay a 10% withdrawal penalty. Annual contribution limits for traditional IRAs in 2024 are $7,000 per account — but if you’re over 50, you can contribute up to $8,000 through catch-up contributions.

2. Roth IRA

Unlike traditional IRAs, Roth IRA contributions are not tax deductible — anything you deposit into your Roth IRA will still count toward your annual income once tax season rolls around. But Roth IRAs offer a different type of tax advantage: Withdrawals are tax-free and you don’t pay tax on capital gains. Plus, withdrawal Roth IRA contributions at any time without taxes or penalties. The same contribution limits that govern traditional IRAs also apply to Roth IRAs: $7,000 per account unless you’re over 50, in which case you can contribute up to $8,000.

3. SIMPLE IRA

SIMPLE IRAs are employer-sponsored retirement accounts, and they’re typically offered by small businesses with 100 or fewer employees. SIMPLE IRAs follow the same contribution and distribution rules as traditional IRAs. Contributions are tax-deductible and your money is taxed in when you begin taking withdrawals.

Employer contributions are mandatory, which means your employer must match what you contribute to your account up to 3% of your pay. Contribution limits apply to SIMPLE IRAs, but are higher than the caps on traditional and Roth IRAs. In 2024, annual contribution limits for SIMPLE IRAs are $16,000 per account — but if you’re over the age of 50, you can contribute as much as $19,500 through catch-up contributions.

4. SEP IRA

A SEP IRA is a retirement account for self-employed individuals. They also work like traditional IRAs: tax-deferred gains and tax-deductible contributions. The difference lies in the contribution limits. In 2024, contribution limits for SEP IRAs sit at $69,000 or 25% of compensation — whichever is less.

To set up a SEP IRA, you must be a sole proprietor or belong to a partnership or corporation.

IRAs at a glance

To sum up, here’s an overview of the differences that separate traditional, Roth, SIMPLE and SEP IRAs.

Traditional IRARoth IRASIMPLE IRASEP IRA
Best forIndividualsIndividualsSmall businesses with 100 or fewer employeesBusinesses of any size, including freelancers and self-employed individuals
Contribution limits$7,000 per account ($8,000 if you’re over 50)$7,000 per account ($8,000 if you’re over 50)$16,000 per account ($19,500 if you’re over 50)The lesser of $69,000 or 25% of compensation
Tax-advantageTax-deductible contributionsTax-free distributionsTax-deductible contributionsTax-deductible contributions

How to open an IRA

Ready to open an IRA? Here’s a quick look at the process:

  1. Choose a broker. Explore your brokerage options across banks, robo-advisors and online trading platforms. Take a close look at commission fees, asset options and service reliability to start narrowing down your choices.
  2. Complete your application. Once you’ve found a broker you like, you’ll need to fill out an account application. Be prepared to supply some personal information, photo ID and your Social Security number. You’ll also need to connect an external account to fund your IRA.
  3. Fund your account. To complete the application process, you’ll need to fund your IRA. This can be done by bank transfer or by rolling over an existing account, like a 401(k).
  4. Select your assets. Choose the stocks, bonds, ETFs or any other assets made available by your broker that you want to invest in. The ideal assets for your account will depend on your time horizon and risk tolerance.
  5. Establish a contribution schedule. Consider setting up regular contributions to your IRA with scheduled bank transfers on a monthly, quarterly or annual basis.

IRA fees

Fees can eat into profits and detract from your retirement nest egg. Before you open an IRA, be prepared to encounter one or more of the following fees:

  • Account maintenance fees. Some brokers charge annual maintenance fees of up to $50, so review the fine print before you sign up.
  • Trading commissions. Many platforms have done away with stock commissions, but you may still encounter trading fees when swapping bonds or other assets.
  • Expense ratios. Exchange-traded funds and mutual funds carry expense ratios: a percentage-based fee that helps cover the cost of operating the fund. Expect to pay an expense ratio of 0.2% to 1.5% when you invest in mutual funds and ETFs.

IRA vs. 401(k): What’s the difference?

Both 401(k)s and IRAs are tax-advantaged investment accounts designed to help you save for retirement. The main difference? Employers offer 401(k)s, while individuals open traditional and Roth IRAs.

These two accounts also differ in terms of investment options and contribution limits. Most 401(k)s are limited to mutual funds, while IRAs allow everything from stocks to ETFs to real estate. 401(k)s also have a higher annual contribution limit, and many employers offer matching contributions.

Pros and cons of IRAs

Consider these pros and cons before opening an IRA:

Pros

  • Tax-advantaged. From tax-deferred contributions to tax-free withdrawals, IRAs allow you to direct how and when your investments are taxed.
  • Self-directed. Unlike the contents of a 401(k), you’re in complete control over the investment strategy of your IRA.
  • Investment selection. IRAs typically allow for a wide range of investment classes, including stocks, bonds, mutual funds, ETFs and more.

Cons

  • Contribution limits. No matter what type of IRA you hold, your contributions will be capped at the annual limit set by the IRS.
  • Withdrawal penalties. If you pull funds from your IRA before the age of 59.5, you’ll face a 10% early withdrawal penalty.

Can I avoid an early withdrawal penalty?

Yes, there are a handful of circumstances in which you can withdraw funds from your traditional IRA ahead of schedule and avoid the 10% withdrawal penalty, including:

  • To cover unreimbursed medical expenses
  • To cover health insurance premiums while unemployed
  • To cover higher education expenses
  • To cover the cost of buying, building or rebuilding a home
  • You’re called to active duty
  • You become permanently disabled
  • You inherit an IRA
  • You plan to withdraw substantially equal periodic payments
  • The IRS levies the funds directly

Do you have an IRA?

Response% of Americans
I do not have this, but plan on getting it in the next 6 months13%
I do not have this nor plan on getting it56%
I currently have this31%
Source: Finder survey by Qualtrics of 2,033 Americans

While 401Ks are the most popular savings option for American adults (44%) about a third (31%) have an IRA.

Compare brokerages with retirement accounts

1 - 7 of 7
Name Product Minimum deposit Annual fee Retirement account types
SoFi IRA
Finder Score: 4.2 / 5: ★★★★★
SoFi IRA
$0
$0 per month
Roth, Traditional, SEP, Rollover
Trade stocks, options, ETFs, mutual funds and alternative asset funds, with no-cost financial advice and a no-cost robo-advisor.
Tastytrade IRA
Finder Score: 4.3 / 5: ★★★★★
Tastytrade IRA
$0
$0 per year
Roth, Traditional, SEP, Rollover, Beneficiary Traditional, Beneficiary Roth
Invest in stocks, ETFs, options, futures and more in your IRA, with commission-free stock and ETF trades and a powerful trading platform.
JP Morgan Personal Advisors
Finder Score: 3.3 / 5: ★★★★★
JP Morgan Personal Advisors
$25,000
0.6% on balances of $25,000 to $249,999

0.5% on balances of $250,000+
Roth, Traditional
Ongoing access to an advisory team with personalized, expert-built portfolios. Provider terms & conditions apply
Robinhood Retirement
Finder Score: 4.4 / 5: ★★★★★
Robinhood Retirement
$0
0%
Roth, Traditional, Rollover
Boost your retirement savings with 1% in matching funds on every dollar contributed, transferred or rolled over to a Robinhood IRA.
Vanguard IRA
Finder Score: 4 / 5: ★★★★★
Vanguard IRA
$0
0.3%
Roth, Traditional, SEP, Spousal, Rollover
Save for retirement with Vanguard's commission-free stocks, ETFs and 160+ no-transaction-fee mutual funds.
Interactive Brokers IRA
Finder Score: 4.5 / 5: ★★★★★
Interactive Brokers IRA
$0
N/A
Roth, Traditional, SEP, Rollover
Choose from 6 IRA account options, with access to stocks, ETFs , futures, currencies and more.
Acorns Later
Finder Score: 4.2 / 5: ★★★★★
Acorns Later
$0
$3 per month
Roth, Traditional, SEP
Automatic ETF investing with as little as $5. Annual fee of $3, $5 or $9 per month depending on subscription.
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Bottom line

Each type of IRA offers a distinct path to tax-advantaged wealth building. Before you open an IRA, review your retirement investment options with multiple brokers to find the account that’s best equipped to serve your ongoing investment needs.

Frequently asked questions

How many Roth IRAs can I have?

As many as you’d like. In fact, there’s no limit to the number of IRAs you can hold. But doubling down on your IRA count doesn’t necessarily mean you can increase your contributions. Your annual contribution limit will remain the same no matter how many accounts you hold.

Can I lose money in an IRA?

Yes. An IRA is an investment account and any investment you make in that account is subject to risk of loss.

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