What is an IRA?
A breakdown of the different types of individual retirement accounts
An individual retirement account, or IRA, helps you save for retirement while providing certain tax advantages. You open the account with a bank, brokerage firm or other financial institution and use it to typically hold individual stocks, bonds and/or mutual fund investments.
Like 401(k)s and other employer-sponsored accounts, IRAs are tax-advantaged vehicles that allow you to set aside funds for retirement. However, most IRAs are individual accounts that are not tied to your employer. Typically, you set up your own IRA and decide how much you will contribute (up to maximums set by the IRS).
What types of IRAs are there?
There are several different types of IRAs, each with its own pros and cons. They include:
- Roth IRA. With this type of IRA, you benefit from tax-free growth, but your contributions are not tax deductible and you can only contribute to a Roth IRA if you meet certain income limits.1 When you eventually withdraw earnings from your Roth account, your distributions are tax-free, as long as you are at least age 59½ and have held the account for at least five years. You may withdraw contributions from your Roth IRA at any time, both tax- and penalty-free.
- Traditional IRA. Contributions to a traditional IRA are tax deductible as long as you meet certain requirements.2 Qualified withdrawals in retirement are taxed as ordinary income. Any potential growth is tax deferred until withdrawn.
- SEP IRA. A Simplified Employee Pension (SEP) plan is an IRA established by small business owners or self-employed individuals. Only the employer can make contributions to employees' accounts. As with traditional IRAs, contributions are tax deductible, and any earnings are tax deferred until withdrawn.
- SIMPLE IRA. A Savings Incentive Match Plan for Employees (SIMPLE) is also set up by your employer, but employees can decide whether they want to make contributions to the account. Employers are required to either contribute 2% of your salary or make a matching contribution of up to 3% of your salary.
- Spousal IRA. A Roth or traditional IRA that a working spouse opens in their non-working spouse’s name.
- Self-directed IRA. A traditional or Roth IRA that allows you to invest in non-traditional assets such as real estate, gold, private equity, commodities or cryptocurrency.
- Custodial IRA. An IRA that an adult (usually a parent) establishes for a minor with earned income. The custodian manages the assets on behalf of the young person until they reach the legal age to manage the account — either age 18 or 21, depending on the state where they live.
How much can you save in an IRA?
In 2022, you can contribute up to $6,000 to a traditional or Roth IRA. You can add an additional $1,000 if you’re 50 or older. The IRS allows you to contribute to both a traditional and a Roth IRA in the same year, as long as total contributions don't exceed those limits.
If you want to maximize your retirement savings, you can contribute to both a 401(k) and an IRA — but note that your IRA contributions may not be tax deductible if you also have a 401(k). The IRS allows you to contribute up to $20,500 to a 401(k) in 2022, plus an extra $6,500 if you’re 50 or older.
What are the advantages of an IRA?
When you choose to contribute to an IRA, the tax benefits can potentially help your savings grow at a faster rate than they might in a taxable account. Plus, an IRA gives you flexibility in your investment options, allowing you to invest in stocks, bonds, mutual funds and annuities. It can also supplement your employer-sponsored plan, potentially helping you maintain your existing lifestyle when you hit retirement age.
Learn more about Empower's IRAs
1 $144,000 for single filers and $214,000 for joint filers in 2022.
2 If you're a single filer without a workplace retirement plan, or if you have a workplace retirement plan and your income is less than $78,000, contributions are tax deductible. If you're married and filing jointly, the income limit is $129,000. If you're married and filing separately, the limit is $10,000.