Understanding IRA Accounts: Types, Benefits and How They Work

Saving enough money for retirement can be a challenge no matter who you are, but it’s a challenge worth tackling early and sticking with for a lifetime. To make the process easier — and more lucrative — many Americans open individual retirement accounts, better known as IRAs. But the key question is, “What is an IRA?”

An IRA is a type of financial account designed to help people build retirement savings over many years. It’s a good way to get started at a young age, even if you have access to a 401(k) or other type of company-sponsored retirement plan.

IRAs offer tax advantages and investment options that help you grow your nest egg faster than if you simply planted your money in a traditional savings account. There are a few different types of IRAs to choose from, each suited to different needs.

Keep reading to learn about the different types of IRAs and their advantages (and disadvantages).

How Does an IRA Work?

In simple terms, an IRA is a tax-advantaged retirement savings account. Several types of IRAs are available, each with its own rules. Contributions to some IRAs are tax deductible, and in other cases certain withdrawals are tax-free.

Overview of Contributions, Investment Growth and Withdrawals 

For both a traditional and Roth IRA, the 2025 limits are as follows:

• $7,000 for those under 50 
• $8,000 for those 50+

The particular advantage of a traditional IRA is that you can enjoy tax-deferred growth. Keep in mind that when you withdraw these funds in retirement, you will have to pay taxes. For a Roth IRA, you make after-tax contributions and can enjoy uninterrupted growth of those funds in retirement without having to take the required minimum distribution. 

If you decide to withdraw early from your IRA (before the age of 59½), you will incur a 10% penalty and pay income taxes. For your Roth IRA, you will not be penalized for withdrawing your contributions. However, if you withdraw your earnings from your Roth IRA before 59½ and your account has been open less than five years, you will pay a 10% early withdrawal fee and income tax on the earnings.

Types of IRAs

There are several types of IRAs. Let’s take a look at traditional, Roth, SEP and Simple IRAs and their benefits:

Traditional IRA

This is the most popular IRA type and is available to anyone with earned income. Here are some things to know about a traditional IRA:

• Annual contributions and limits: As of 2025, you can contribute up to $7,000 annually to a traditional IRA. If you’re 50 or older, you’re eligible for an additional $1,000 catch-up contribution, bringing your total annual limit to $8,000.
• Taxes: The balance in your traditional IRA will continue to grow tax-deferred until you take a distribution, also known as a withdrawal. You may also be able to deduct part of your contributions from your taxes. With few exceptions, you’ll face a penalty if you take a withdrawal before age 59½.
• Withdrawals: After reaching age 59½, you can access funds without penalties or restrictions. You must begin taking required minimum distributions when you reach age 72 or 73 (depending on your birth year).

Roth IRA

With a Roth IRA, you invest money using after-tax dollars, meaning taxes are not deferred and contributions are not deductible. However, when you reach the distribution stage, your money can be withdrawn tax-free. 

Eligibility for a Roth IRA is based on your income level (you can learn more by visiting the IRS site). The contribution limits for a Roth IRA are the same as a traditional IRA. As with traditional IRAs, you could face a penalty for withdrawing funds from your Roth IRA before age 59½.

SEP IRA

The Simplified Employee Pension IRA is a traditional IRA that employers can set up for themselves and their workers. Contributions are made by the employer and change yearly based on the business’s cash flow, according to U.S. Bank. For tax year 2025, contributions are limited to the lesser of the following: 25% of employee compensation, or $70,000. 

You can’t make catch-up contributions with a SEP IRA, though your earnings grow tax-free and are subject to most of the same rules as traditional IRAs.

SIMPLE IRA

SIMPLE IRA plans are similar to traditional IRAs and feature tax-deferred and tax-deductible contributions. Employees can contribute up to $16,500 in 2025, with an additional $3,500 catch-up contribution for those 50 or older. Employers are required to provide up to a 3% matching contribution or a 2% fixed contribution of each eligible employee’s compensation, according to U.S. Bank.

Benefits of an IRA

Wondering about the benefits of an IRA? For a traditional IRA, you can enjoy tax-deferred growth. Talk to a financial advisor to decide if this is a good strategy based on your financial portfolio. Your advisor may suggest that you opt for a Roth IRA that allows you to contribute after taxes and enjoy tax-free withdrawals in retirement. 

An IRA also offers flexibility in investment options because you can choose stocks, bonds, mutual funds and ETFs. An IRA can help your account balance compound quickly compared to savings accounts, certificates of deposit and money market accounts.

IRA Contribution Limits

There are contribution limits with your IRA. You can contribute up to $7,000 in 2025 to your traditional or Roth IRA, and those over 50 can contribute $8,000.

There are income restrictions for Roth IRA eligibility. Here’s a table that shows the limits:

2024 & 2025 Roth IRA Income Limits and Contribution Rules

Roth IRA contributions are subject to income restrictions based on filing status. The table below outlines the income limits for 2024 and 2025, along with the corresponding contribution eligibility.

Rules for combining IRA contributions with other retirement plans

You are allowed to contribute to your 401(k) plan and IRA. Also, employer contributions don’t affect IRA Limits. Any employer match in your 401(k) does not impact how much you can contribute to an IRA.

However, your ability to deduct your traditional or Roth IRA contributions may be limited depending on your income. 

How to Open an IRA

Opening an IRA isn’t complicated. Follow these steps and you can start investing in your IRA immediately: 

1. Choose the type of IRA: Depending on whether you want to pay taxes now or later, decide whether you want a traditional IRA (tax-deferred contribution) or a Roth IRA (after-tax contribution). You may want to consult with a financial advisor before making your decision. 
2. Select a provider: Depending on your preference, you may want to choose between a bank, brokerage firm or robo-advisor. This decision depends on your investment management preference.
3. Open the account: You can open your account and fund through external funds or rollovers.  
4. Begin investing in eligible assets: Choose from stocks, bonds, mutual funds, ETFs and other eligible assets to grow your retirement savings.

Tips for comparing IRA providers 

You can take a look at the fees, investment providers, customer service, ease of use of the platform and the type of advisors. 

• Fees: You want to choose a firm that has minimum account fees and trading costs. 
• Variety of options: Choose a provider with a wide range of stocks, bonds, ETFs and mutual funds.
• Customer service: You want a provider that has good reviews, is responsive to calls and has educational tools that are easy to access. 
• Easy-to-use platform: Make sure the platform is easy to use especially if you plan to manage the investments yourself. 
• Robo advisors vs. human advisors: If you want to forego robo advisors and consult with human financial advisors, evaluate that element in the platform you decide to choose. 

IRA Rules and Guidelines

What are the IRA rules and guidelines regarding contributions and what penalty will you pay if you withdraw early?

In 2025, the contribution limit is $7,000 to a traditional IRA and Roth IRA if you are under 50. The contribution limit is $8,000 to a traditional IRA and a Roth IRA if you are 50+. You must contribute by the tax deadline of April 15 of the following year. 

Penalties for Early Withdrawals

What happens if you want to withdraw from your IRA? It depends on your age. You will face a traditional IRA penalty of 10% on withdrawals and owe income tax if you withdraw before 59½. 

Roth IRA withdrawals of contributions are penalty-free, but earnings may be taxed.

Required Minimum Distributions for traditional IRAs

For a traditional IRA, you must start taking required minimum distributions at age 73 if you’re born between 1951 and 1959 and at age 75 if you’re born after 1960.

There’s no required minimum distribution for a Roth IRA. 

Prohibited transactions 

Certain transactions are prohibited with your IRA. You cannot do the following: 

• No self-dealing: You cannot borrow from your IRA.
• No investments in collectibles: You cannot invest in collectibles like art and antiques. 
• No investments in real estate: You cannot invest in real estate that is used personally.
• No loans to family members: You are also prohibited from using IRA funds for loans to family members or businesses you control. 

IRA vs. 401(k): Key Differences

What are the key differences between an IRA and 401(k)? 

Who Should Consider an IRA?

If you don’t have an IRA, should you add this investment vehicle to your financial portfolio? For many, adding an IRA does make sense.

Let’s look at a few scenarios when getting an IRA may align with your financial goals:

• Employed, but no retirement plan: If you’re employed but your employer doesn’t offer access to a sponsored retirement plan, you can benefit from an IRA for either tax-deferred or after-tax contributions. 
• You have a 401(k), but want to supplement: Maybe you have a 401(k), but want an additional investment opportunity to grow your income tax-deferred. You should consider investing in a traditional IRA. 
• Younger individuals who want to benefit now: If you’re a younger individual, you should consider a Roth IRA. It is highly likely that if you’re young, you fall into a lower tax bracket. Since Roth IRAs are funded with after-tax contributions, take advantage of being in a lower tax bracket now. You will be able to take withdrawals tax-free in retirement and aren’t pushed into a required minimum distribution.

Final Take to GO

Understanding IRA accounts is key to making smart retirement decisions. Whether you choose a Traditional IRA for tax-deferred growth or a Roth IRA for tax-free withdrawals, each account offers unique benefits depending on your financial situation. Self-employed individuals and small business owners can also explore SEP and SIMPLE IRAs to maximize contributions and tax advantages.

Next Steps

• Compare IRA Options: Review the differences between Traditional, Roth, SEP, and SIMPLE IRAs to find the best fit for your goals.
• Check Eligibility & Contribution Limits: Ensure you meet income requirements and stay within the IRS limits to maximize benefits.
• Start Investing Early: The sooner you contribute, the more time your money has to grow through compound interest.
• Consult a Financial Advisor: If you’re unsure which IRA works best for you, speaking with a professional can provide clarity.

A well-planned IRA strategy can help secure your financial future, so take the next step today. Want to dive deeper? Explore our expert IRA guides here.

Information is accurate as of March 18, 2025.

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