What Is an IRA?

Individual retirement accounts (IRAs) are personal retirement savings plans that offer tax benefits and a wide range of investment options. Many investors use IRAs as a tool to save for retirement. And even those with access to employer-sponsored plans—such as a 401(k) or 403(b)—can still tap an IRA's tax advantages to boost their savings and add flexibility to their portfolio.

"After you've contributed up to the employer match in your employer-sponsored plan—if you're eligible—an IRA may be the next best way to save for retirement," says Rob Williams, head of financial planning and wealth management research for the Schwab Center for Financial Research. "IRAs may offer a wider range of investment options than your 401(k), such as individual stocks or bonds, if that's your preference."

There are different types of IRAs, and they each have their own rules for contributions, withdrawals, and taxes. "Which IRA is right for you will depend on your personal situation, such as your income, whether you prefer potential tax savings now or in retirement, how required minimum distributions fit into your long-term plan, and whether you expect to be in a higher or lower tax bracket in retirement," says Rob.

The three most common types of IRAs are traditional IRAs, Roth IRAs, and rollover IRAs.

With a traditional IRA, contributions may be tax-deductible, meaning you could get a tax break up front. You'll have to pay income tax on your traditional IRA distributions when you start making withdrawals in retirement, and you'll be required to take required minimum distributions (RMDs) each year starting at age 73. Anyone with earned income can contribute to a traditional IRA. However, if you or your spouse is covered by an employer plan, like a 401(k), there are income limits for making tax-deductible contributions to a traditional IRA. If you exceed those income limits, you will not be eligible to contribute to an IRA with pre-tax funds. You can, however, still make nondeductible contributions—or contributions made with after-tax dollars—and benefit from potential tax-free growth.

Roth IRAs treat taxes differently. Like a traditional IRA, you need to have earned income to contribute to a Roth IRA. Instead of receiving an immediate tax deduction, you can only contribute after-tax dollars (income you've already paid taxes on). But your money can grow tax-free and qualified withdrawals are tax-free in retirement. Roth IRA contributions may be withdrawn at any time without additional tax or penalty. And earnings can be withdrawn tax-free after age 59½, if you've held the account for at least five years. (The IRS maintains a list of exceptions to early withdrawal restrictions.) Roth IRAs are not subject to RMDs, so you can leave the money in your account as long as you choose or even leave it to your heirs. But in order to contribute to one, your income must fall below a certain limit.

A rollover IRA, by contrast, allows you to move funds from your old employer-sponsored retirement plan—for example, a 401(k)—into an IRA. "Rolling over" your savings in this way may allow you to preserve the tax-deferred status of your retirement assets, thus avoiding taxes or early withdrawal penalties at the time of transfer. But the specific tax benefits, as well as whether you'll be subject to RMDs, will depend on the type of IRA you roll into—usually a traditional or Roth IRA.

In addition to the three types of IRAs above, there are others you may have access to, depending on your situation:

• SIMPLE IRA: A Savings Investment Match Plan for Employees (SIMPLE) is a low-cost retirement plan for self-employed individuals and small businesses with 100 or fewer employees. Employers can save for their own retirement and make contributions for employees. Employees can also contribute.
• SEP-IRA: A Simplified Employee Pension (SEP) plan is another way for self-employed individuals and business owners to set up a retirement savings plan for themselves and their employees. These accounts are funded by the employer, and contribution limits are higher than other types of IRAs.
• Inherited IRA: These accounts—also known as Beneficiary IRAs—are opened when someone inherits a traditional or Roth IRA after the death of the original owner.
• Custodial IRA: Any parent, grandparent, or other custodian can open a traditional IRA or Roth IRA for a minor who has earned income for the year. The minor assumes ownership of the account when they reach the age of adulthood determined by state law.
• Spousal IRA: You usually need earned income to open and fund an IRA, but not with a spousal IRA. This plan allows the working spouse to fund a traditional IRA or Roth IRA for a spouse who does not have earned income. To qualify, you must file a joint tax return.