What Is an IRA and How Does It Work?

What is an IRA?

IRA stands for Individual Retirement Account. At its core, it's an investment account designed to help you save for retirement while benefiting from certain tax advantages. You contribute money to the account, invest it in assets of your choosing, and watch it grow -- either tax-deferred or tax-free, depending on the type of IRA you hold.

All IRAs share one key feature: as long as your investments remain inside the account, you won't owe taxes on dividends, interest, or capital gains each year. This ability to compound without an annual tax drag is what makes IRAs so effective over a multi-decade investment horizon.

You can open an IRA at virtually any major financial institution, including online brokers, traditional banks, robo-advisors, and investment management firms. Once the account is funded, you can invest in stocks, bonds, ETFs, mutual funds, CDs, money market accounts, and more.

Types of IRAs

There are four main types of IRAs, each designed for a different situation.

Traditional IRAs

Traditional IRAs allow you to invest pretax income toward your retirement. You contribute money before it's taxed, your investments grow on a tax-deferred basis, and withdrawals in retirement are taxed as ordinary income. Contributions may also be tax-deductible in the year you make them, depending on your income and whether you have access to a workplace retirement plan. The traditional IRA is the right choice if you expect your tax rate to be lower in retirement than it is today -- you claim the deduction now, when it's worth more, and pay taxes later at a lower rate.

Roth IRAs

A Roth IRA flips the tax structure. Contributions are made with after-tax dollars, so there's no upfront deduction. But your money grows completely tax-free, and qualified withdrawals in retirement are 100% tax-free. Roth IRAs also have no required minimum distributions during your lifetime, making them a flexible estate planning tool. They're the better choice if you expect your tax rate to be higher in retirement. An added benefit: Roth IRA distributions don't count toward the income thresholds that make Social Security benefits taxable.

SEP IRAs

Small business owners and self-employed individuals can set up Simplified Employee Pension IRAs, or SEP-IRAs. Only the employer, or self-employed account owner, makes contributions; employees cannot contribute to their own SEP-IRA.

Contribution limits are significantly higher than standard IRAs: up to 25% of compensation or $70,000 in 2025 and $72,000 in 2026, whichever is less. There are no income limits for contributing. SEP-IRAs are taxed like traditional IRAs -- contributions are deductible and withdrawals are taxed as income.

SIMPLE IRAs

The Savings Incentive Match Plan for Employees IRA is another small-business option, but with one key difference: both employers and employees can contribute. Employees may contribute up to $16,500 in 2025 and $17,000 in 2026. Employers must contribute as well, either matching employee contributions up to 3% of salary or making a flat 2% contribution for all eligible employees regardless of whether they contribute themselves. SIMPLE IRAs are taxed like traditional IRAs and have no income limits.

Two additional IRA types are worth knowing

1. A rollover IRA isn't a separate category so much as a process — transferring money from a former employer's 401(k) or other retirement plan into an IRA. To avoid a taxable event, roll a traditional 401(k) into a traditional IRA, or a Roth 401(k) into a Roth IRA. You have 60 days to complete the rollover before the IRS treats it as a withdrawal.
2. A spousal IRA is a standard traditional or Roth IRA that a working spouse funds on behalf of a non-working or low-earning spouse. Contribution limits are the same as a standard IRA, and it's one of the most effective ways to keep retirement savings growing in a single-income household.

Contribution limits

IRA contribution limits are set by the IRS and adjust periodically. For traditional and Roth IRAs, the limit is $7,000 in 2025 and $7,500 in 2026. Those 50 and older can make an additional catch-up contribution of $1,000 in 2025 and $1,100 in 2026, bringing their totals to $8,000 and $8,600 respectively.

This limit applies per person, not per account. If you hold both a traditional and a Roth IRA, your combined contributions across both cannot exceed the annual cap. For example, in 2026 you could contribute $4,000 to a traditional IRA and $3,500 to a Roth IRA, but not $7,500 to each.

SEP-IRA and SIMPLE IRA limits are considerably higher, as noted in the types section above. Workers aged 60–63 in SIMPLE IRA plans also benefit from a special enhanced catch-up: up to $5,250 in both 2025 and 2026, higher than the standard catch-up available to those 50 and older.

You can make contributions for a given tax year all the way up to the tax filing deadline: typically April 15 of the following year. That means 2025 contributions can be made as late as April 15, 2026.

Who's eligible for an IRA?

Anyone with earned income can contribute to a traditional IRA, but the ability to deduct those contributions is where income and workplace plan access come into play.

If neither you nor your spouse participates in a retirement plan at work, your traditional IRA contributions are fully deductible regardless of income. But if you or your spouse has access to a workplace plan, the deduction begins to phase out above certain income thresholds. For 2025, the phase-out starts at $79,000 for single filers with a workplace plan, $126,000 for married joint filers where the contributing spouse has a plan, and $236,000 for joint filers where only the non-contributing spouse has a plan. These thresholds rise in 2026 to $81,000, $129,000, and $242,000 respectively.

Roth IRA eligibility is income-restricted regardless of workplace plan access. Above the IRS's annual income phase-out range, you cannot contribute directly to a Roth IRA. High earners may consider a "backdoor Roth" conversion — consult a financial advisor about whether that strategy fits your situation.

SEP-IRAs and SIMPLE IRAs have no income restrictions, since they're designed as small-business retirement vehicles.

Advantages of IRAs

IRAs have several advantages, such as:

• You have a choice of investment accounts: You can decide between traditional and Roth IRAs, depending on whether you would prefer your tax break upfront during the year you contribute or would prefer to defer your tax savings until you are a retiree. You also have the choice to contribute to accounts that provide higher contribution limits if you are self-employed or own your own business.
• Contributions provide significant tax advantages: Traditional IRAs allow you to contribute to your account with pretax dollars, while Roth IRAs allow you to benefit from tax-free withdrawals in retirement. You can choose whether to save on taxes now or in your later years.
• You do not need an employer to open an IRA for you: Although there are a few types of IRAs that employers can offer for employees, you can set up the most common IRA account types (traditional and Roth) for yourself. You have the option to use an IRA as a supplement to a workplace savings plan, or you can open one to take advantage of tax breaks for retirement savings if your employer doesn’t offer a 401(k) or similar plan type.
• Opening an IRA is simple. If you are a self-employed worker or own your own business, SEP and SIMPLE IRAs can be easier to establish than other types of workplace retirement plans, such as a 401(k).
• You have more flexibility in investment options: You can choose from a wide variety of financial institutions to hold your IRA, including brokerage accounts, robo-advisors, banks, and self-directed IRAs. These types of accounts also usually offer several different investments to choose from, so you can invest your money in a wider variety of assets than would be available in a typical workplace 401(k) plan.
• Most institutions allow you to open an IRA with no fees and no minimum balance: Many brokers and banks make it easy to get started investing, with few or no costs associated with opening or maintaining your account.
• You can borrow from your account. This is an option as long as you follow the rules about borrowing from your IRA.

IRA FAQs