Last updated: October 17, 2026
- How an IRA works
- Traditional IRA vs Roth IRA
- Example of IRA tax benefits
- Withdrawals and penalties
- Things to consider
- FAQ
- Related terms
How an IRA works
An IRA is opened by an individual, not an employer, at a bank, brokerage, or other approved custodian. You contribute money, choose investments, and the account's growth is sheltered from annual taxes on interest, dividends, and capital gains as long as the money stays inside. The IRS sets annual contribution limits, with an additional catch-up amount allowed for people age 50 and older. Contributions generally require earned income.
Inside the account you can usually hold stocks, bonds, mutual funds, ETFs, and cash. Some activities are restricted; for example, IRAs generally cannot borrow on margin, and certain collectibles are prohibited.
Traditional IRA vs Roth IRA
- Traditional IRA: contributions may be tax-deductible, depending on income and workplace plan coverage. Growth is tax-deferred, and withdrawals in retirement are taxed as ordinary income. Required minimum distributions begin at an age set by federal law.
- Roth IRA: contributions are made with after-tax dollars and are not deductible. Qualified withdrawals, including earnings, are tax-free. Eligibility to contribute phases out at higher incomes, and the original owner is not required to take minimum distributions.
Choosing between them often comes down to whether you expect your tax rate to be higher now or in retirement.
Example of IRA tax benefits
Suppose an investor contributes a hypothetical $6,000 per year for 30 years and earns 6% annually. The account would grow to roughly $474,000. In a taxable account, yearly taxes on dividends and realized gains would reduce the compounding. In a traditional IRA, the full amount compounds, but withdrawals are taxed later. In a Roth IRA, the investor paid tax on the $6,000 each year, yet the $474,000 could be withdrawn tax-free if the rules for qualified distributions are met.
Withdrawals and penalties
Withdrawals before age 59 1/2 are generally subject to ordinary income tax on the taxable portion plus a 10% additional tax, though exceptions exist, such as certain first-time home purchases, qualified education expenses, and disability. Roth contributions (but not earnings) can generally be withdrawn at any time without tax or penalty. Rollovers let you move money from a workplace plan, such as a 401(k), into an IRA without triggering tax if done correctly.
Things to consider
An IRA is an account type, not an investment, so returns depend on what you hold within it. IRA balances at a brokerage are not covered by FDIC insurance unless held in bank deposits. Rules change over time, so confirm current limits and eligibility with the IRS or a tax professional.
Frequently asked questions
What is the difference between an IRA and a 401(k)?
A 401(k) is an employer-sponsored plan, often with matching contributions, while an IRA is opened individually and usually offers a wider choice of investments.
Can I have both a traditional IRA and a Roth IRA?
Yes. You can hold both, but the annual IRS contribution limit applies to the combined total of your traditional and Roth IRA contributions.
Can I lose money in an IRA?
Yes. An IRA holds investments such as stocks and bonds, and their value can fall. The tax benefits do not protect against market losses.
Related terms
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For information only, not investment advice. See the disclaimer.