1 Smart Decision That Could Open the Door to a Million-Dollar Nest Egg

An individual retirement account, or IRA, is a specialized type of investment account designed to help people save money for retirement. It can be one of the most powerful wealth-building tools available to American workers. Not only can an IRA allow you to save and invest for retirement in a tax-deferred manner, but there are some other big reasons to open one and contribute often.

Here's a rundown of how much you can invest in an IRA, how they can save you more on your taxes than you think, and how you could build a million-dollar nest egg over time.

How much can you put into an IRA?

The IRS sets an annual maximum IRA contribution each year. For 2023, the contribution limit is $6,500, with an additional $1,000 allowed for investors 50 and older as a catch-up contribution. For 2024, the limit is rising to $7,000, with the same catch-up allowance.

It's also worth noting that you can make IRA contributions until each year's April tax deadline (this is why I just mentioned the 2023 limits, even though we're well into 2024). In other words, if you open an IRA this month or next, you can still make your 2023 IRA contributions until April 15 and potentially save money on your tax return right away.

To contribute to an IRA, you need to have earned income from a job or business you participate in. To qualify for a tax benefit, you'll need to meet certain requirements, which I'll discuss more in a bit.

Traditional or Roth?

There are two main types of IRA you can open with an online broker -- traditional or Roth. There are a couple other types available if you're self-employed, but these are the options that anyone can open.

There are a few differences between the two, but the most significant is the tax treatment.

Traditional IRA contributions can potentially be deducted on your current-year tax return, which can save you a ton of money. As an example, if you max out a $7,000 IRA contribution for 2024 and you're in the 22% tax bracket, you could save $1,540 on your 2024 federal income tax.

On the other hand, Roth IRA contributions are not tax deductible, but qualified withdrawals after you retire are completely tax free, regardless of how much your investments have grown. On the other hand, traditional IRA withdrawals are treated as taxable income.

Generally speaking, traditional IRAs are best for those who want to save money on their taxes now, while Roth IRAs are best suited to people in lower tax brackets now who want tax-free retirement income.

Can you open an IRA if you already have a 401(k) at work?

The short answer is yes. But if you have a 401(k) at work, or if you're married and your spouse does, it might limit your ability to take a tax deduction for your traditional IRA contributions. Roth IRA contributions are income-restricted for everyone. The short version of the rules is that to make a full contribution to a Roth IRA for 2024, your adjusted gross income (AGI) must be less than $146,000 (single filers) or $230,000 (married filing jointly).

Special features of IRAs

IRAs have some key advantages over 401(k)s and similar plans when it comes to flexibility. While you cannot borrow from an IRA like you can with most 401(k)s, you can withdraw up to $10,000 without penalty to use toward a first-time home purchase for you or someone else.

Plus, you can use any amount to help pay for college. In fact, many people use IRAs to save for college instead of 529 plans. You can withdraw the money to pay for college, but if your kids end up not needing it, you can simply keep it for your own retirement.

How much could your money grow in an IRA?

Once you've deposited money into an IRA, it can be invested in stocks, bonds, mutual funds, ETFs, and other types of assets. If you don't want to pick your own investments, many brokers offer automated investing, or robo-advisory services that will construct an appropriate portfolio for you.

While it's impossible to predict what your investments will do in the future, the stock market has produced annualized returns of about 10% on average over long periods. Based on this rate, and a $7,000 annual contribution rate, an IRA could produce a $1.15 million nest egg after 30 years.

An IRA investor's best assets are contributions and time. So, there's no better time to get started with an IRA through a top online broker than right now.