How does an IRA work?

Learn how IRAs work, including IRA tax advantages and other IRA benefits, and understand the difference between an IRA and 401(k), with our at-a-glance guide to individual retirement accounts.

One of the most popular—and useful—tools you can use for retirement savings is an individual retirement account (IRA).

Think of an IRA as a bucket that you can fill with stocks, bonds, mutual funds, exchange-traded funds (ETFs) and other investment vehicles.

The investments in your IRA bucket provide tax advantages that regular investments don’t offer. Even better, the money you invest in an IRA is compounded tax-free year over year, helping your nest egg grow over time.

Here are some common questions about how an IRA works and whether it could be a good option for you as you save for retirement.

Traditional IRA vs Roth IRA: Which should I choose?

It depends on your goals. The biggest difference between traditional IRAs and Roth IRAs is how they’re taxed. There are also differences related to withdrawals and required distributions. 

Roth IRA: “Tax-free.”

• You invest after-tax dollars in a Roth IRA.
• If you take withdrawals before age 59 ½ and the account is less than five years old, you may be subject to taxes and a 10% penalty.
• You’re not taxed on withdrawals after age 59 ½ and as long as you’ve held the account for five years.
• Roth IRAs do not have required minimum distributions (RMDs).
• Roth IRAs can be useful if you’re a younger investor and are in a lower tax bracket than you expect to be as you progress in your career.

Traditional IRA: “Tax-deferred.”

• You may be eligible to receive a tax deduction on the money you contribute to your traditional IRA each year.*
• As with a Roth IRA, if you withdraw money before age 59 ½ you may be subject to a 10% penalty in addition to taxes.
• Distributions after age 59 ½ will be taxed as ordinary income.
• Traditional IRAs require you to take RMDs starting at age 73. 

Learn more about different types of IRA accounts.

When can I open an IRA, and how much can I contribute to an IRA?

You can open either a Roth or traditional IRA by the tax filing deadline of the previous year. If you open a traditional IRA, you may be able to deduct your contribution and reduce your taxable income for that tax year.*

The amount of money that you contribute to an IRA before the tax deadline counts toward the prior year’s limit ($7,000 for tax year 2024). For example, if you open a new IRA in January, you could jumpstart your investment by contributing $7,000 before the tax deadline and then another $7,000 (or whatever the current limit) before the tax deadline of the following year. 

Should I choose an IRA, a 401(k) or both?

Many people have both an IRA and a 401(k), because they both will help toward their retirement goals. Here’s a look at the requirements and benefits of each. 

How do I manage an IRA?