Table of Contents
- What Is an IRA?
- How Does an IRA Work?
- Types of IRAs
- IRA Contribution Limits
- Do You Need Earned Income to Contribute to an IRA?
- What Can You Invest in With an IRA?
- Benefits of an IRA
- IRA Rules and Potential Drawbacks
- IRA vs. 401(k): What’s the Difference?
- Which Type of IRA May Be Right for You?
- When Is the IRA Contribution Deadline?
- How to Open an IRA
- IRA Withdrawal Rules to Know
- FAQ
An individual retirement account, or IRA, is a tax-advantaged account designed to help you save and invest for retirement. Unlike a 401(k), which is offered through an employer, an IRA is opened by an individual through a brokerage, bank, or other financial institution. There are different types of IRAs, and contributions and withdrawals may be handled in various ways and receive different tax treatment.
IRAs are an option to explore if you don’t have access to a workplace retirement plan or you want to save even more for retirement. Here’s how IRAs work, the main types to know about, and what to consider before opening an IRA.
Key Points
• An IRA is a tax-advantaged account designed to help individuals save and invest for retirement.
• Traditional and Roth IRAs are the most common IRA types for individual savers.
• SEP and SIMPLE IRAs are often used by self-employed people and small businesses.
• Annual IRA contribution limits apply across traditional and Roth IRAs combined.
• IRAs can hold a range of investments such as stocks, bonds, mutual funds, and exchange-traded funds (ETFs), depending on the provider.
• IRA withdrawals before age 59 ½ may be subject to taxes or penalties unless an exception applies.
What Is an IRA?
An IRA is a retirement account that can provide tax advantages while you save and invest for the future. An IRA allows money to potentially grow over the long-term with certain tax advantages.
There are different types of IRAs but two of the most common are traditional IRAs and Roth IRAs. Both types have the same contribution limits each year. A key difference between them is the way the two accounts are taxed.
With a traditional IRA, eligible contributions are tax-deductible upfront, and withdrawals in retirement are taxed as ordinary income. With a Roth IRA, contributions are made with after-tax dollars and are not tax deductible, but qualified withdrawals in retirement are tax-free.
How Does an IRA Work?
After opening an IRA, you fund it with contributions, then choose investments within the IRA. Depending on the provider, investment options may include mutual funds, exchange-traded funds (ETFs), stocks, bonds, certificates of deposit (CDs), and more.
An individual might also choose a managed portfolio for their IRA, in which a financial advisor or robo advisor manages the portfolio on their behalf, buying, selling, and overseeing assets within the IRA based on the individual’s goals and risk tolerance.
Here’s a quick and simple way to think about how an IRA works and what an individual needs to do to get started:
• Open an IRA with a brokerage, bank, online bank, or other financial institution.
• Choose the type of IRA that fits your situation, such as a traditional IRA or Roth IRA.
• Contribute money, subject to annual limits set by the IRS and eligibility rules.
• Invest the money in the account based on your goals, risk tolerance, and timeline.
• Let the account grow tax-deferred or potentially tax-free, depending on the IRA type chosen.
• Withdraw money in retirement according to IRA withdrawal rules.
It’s important to be aware that because investments in an IRA can rise or fall in value, it is possible to lose money with an IRA. The level of risk depends on how the account is invested as well as market performance.
Types of IRAs
As mentioned above, there are numerous types of IRAs. Some are designed for individual savers, while others are geared toward those who are self-employed, small-business owners, or beneficiaries who inherit an IRA.
It is possible to have multiple IRAs of virtually any type, but the rules governing the different plans and the contribution limits can be challenging to stay on top of.
Here’s an at-a-glance comparison of some of the common different types of IRAs and what you need to know about each.
| Type of IRA | Designed for | Tax treatment | Key considerations |
|---|---|---|---|
| Traditional IRA | Individuals with earned income | Contributions may be tax deductible; withdrawals generally taxed as income | Deductibility of contributions may be limited; required minimum distributions (RMDs) typically apply |
| Roth IRA | Individuals with earned income who meet income eligibility rules | Contributions are made with after-tax dollars; qualified withdrawals are tax-free | Income limits may reduce or eliminate contributions; no RMDs for the original account holder |
| Rollover IRA | Individuals moving funds from a previous employer’s workplace plan | Rolling over the funds is typically tax-free; withdrawals are generally taxed. | There are different rollover options to understand and compare |
| SEP IRA | Self-employed individuals and small business owners | Contributions can only be made by an employer and are tax deductible; withdrawals are generally taxed | Higher contribution limits than traditional/Roth IRA |
| SIMPLE IRA | Small business owners and eligible employees | May be a Roth or traditional SIMPLE IRA with contributions and withdrawals taxed accordingly | Employer-sponsored plan with its own limits and rules |
| Custodial IRA | Minors with earned income | May be a Roth or traditional IRA | Adult custodian manages the account until the minor comes of age |
| Inherited IRA | Beneficiaries of IRAs | Taxes depend on account type and beneficiary status | Distribution rules are complex |
Traditional IRA
A traditional IRA is a retirement account that allows individuals to make contributions with pre-tax dollars. Money in the account grows tax deferred and withdrawals are taxed in retirement. Contributions to a traditional IRA are generally tax deductible upfront and can lower an individual’s taxable income.
Withdrawals made before age 59 ½ are typically subject to taxes and a 10% early withdrawal penalty. Traditional IRA account holders must take required minimum distributions (RMDs) from the account beginning at age 73.
Traditional IRAs may be an option for people who want a possible tax break now and expect to be in a lower tax bracket in retirement. However, the ability to deduct contributions can depend on income, filing status, and whether you or your spouse are covered by a workplace retirement plan.
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Roth IRA
Contributions to a Roth IRA are made with after-tax dollars. There is no tax deduction for contributions, but money in the account grows tax-free and qualified withdrawals in retirement are tax-free.
Roth IRA withdrawal rules are more flexible than the rules for a traditional IRA. Contributions to a Roth can generally be withdrawn tax- and penalty-free any time. However, earnings withdrawn before age 59 ½ are subject to taxes and a 10% penalty. Roth IRAs are not subject to RMDs for the original account owner.
Roth IRAs may be an option for those who expect to be in a higher tax bracket in retirement, however, the amount an individual can contribute may be limited by their income and tax-filing status.
Rollover IRA
A rollover IRA is typically used to move money from an employer-sponsored retirement plan like a 401(k) after leaving a job. When a 401(k) is rolled over to an IRA, the money in the account remains tax-advantaged — meaning the individual typically does not pay taxes on it at that time. If you have a traditional 401(k), you can roll it over into a traditional IRA; if you have a Roth 401(k), you can roll it over into a Roth IRA. Withdrawals are taxed according to the usual traditional or Roth IRA rules.
Before completing a rollover, you can research your options. In addition to rolling over your 401(k) into an IRA, you might be able to keep your money in the former employer’s plan, move it to a new employer’s plan, or take a distribution. Each option has consequences, including tax implications, so it’s wise to explore them thoroughly before deciding.
SEP IRA
A Simplified Employee Pension (SEP) IRA gives self-employed people and small-business owners a way to contribute to their own and their employees’ retirement plans. Only an employer or self-employed individual can contribute to a SEP IRA, and contributions are significantly higher than they are for traditional IRAs or Roth IRAs. However, SEPs have specific guidelines for contributions.
SEPs follow the same rules as traditional IRAs regarding early withdrawal penalties and RMDs.
SIMPLE IRA
A Savings Incentive Match Plan for Employees, or SIMPLE IRA, is a type of traditional IRA that both employers and employees can contribute to. These plans are typically available to businesses with 100 employees or fewer.
Employees can make salary deferral contributions, and employers generally must make matching or nonelective contributions each year, even if employees don’t make a contribution to the plan.
SIMPLE IRAs have RMDs, and early withdrawals are generally subject to taxes and a penalty of at least 10%.
Custodial IRA
A custodial IRA is an IRA opened for a minor who has earned income. It can be set up as a traditional IRA or a Roth IRA. An adult custodian manages the account until the child reaches the age of majority, which can vary by state.
Inherited IRA
An inherited IRA is an account opened by someone (typically known as a beneficiary) who inherits an IRA. Beneficiaries cannot contribute additional funds to the IRA. Inherited IRA distribution rules can depend on the original account type, the beneficiary’s relationship to the original owner, and other factors.
Inherited IRA rules can be complex, so beneficiaries may want to consult a financial or tax professional.
IRA Contribution Limits
IRA contribution limits are set by the IRS and can change from year to year. If you have more than one traditional or Roth IRA, it’s important to be aware that the total annual limit applies across these accounts combined, not separately to each account.
Individuals ages 50 and up can make additional catch-up contributions to an IRA to help save for retirement. Limits for catch-ups are also set by the IRS.
| Tax year | Under age 50 | Age 50 and older (with catch-up contribution) |
|---|---|---|
| 2025 | $7,000 | $8,000 |
| 2026 | $7,500 | $8,600 |
SEP IRAs, SIMPLE IRAs, and employer-sponsored retirement plans have separate contribution limits.
Do You Need Earned Income to Contribute to an IRA?
To contribute to a traditional or Roth IRA, you generally need earned income. Examples of earned income include wages, salaries, tips, commissions, bonuses, and net earnings from self-employment.
Investment income, Social Security benefits, pension income, and other income that is not related to working, such as income from a rental property, generally does not count as compensation for IRA contribution purposes.
One exception to the earned income rule is a spousal IRA. In the case of a married couple filing jointly with a nonworking spouse, the working spouse may be able to contribute to a spousal IRA for their partner as long as they have enough taxable compensation and meet other eligibility rules.
What Can You Invest in With an IRA?
An IRA is not an investment by itself. It is an account that can hold investments.
Depending on your IRA provider, you may be able to invest in such assets as:
• Stocks
• Bonds
• Mutual funds
• ETFs
• CDs
The investments you choose can affect the level of investment risk within your IRA and the possible return you may get. For example, stocks and stock funds may offer higher growth potential over time, but they can also be more volatile. Bonds and CDs may be more conservative, but they may also offer lower growth potential.
Benefits of an IRA
An IRA can offer a number of advantages when saving for retirement, such as:
Tax-Advantaged Retirement Savings
Depending on the type of IRA you have, you may receive tax benefits upfront when you make contributions or when you take qualified withdrawals in retirement.
Ability to Save Outside of Work
An individual can open an IRA outside of an employer-sponsored retirement plan. That can be helpful to those who don’t have access to a workplace plan or want to save even more for retirement.
Investment Choices
IRAs typically offer a wide range of investment choices, depending on the provider. This might include mutual funds, ETFs, stocks, bonds, CDs, and more.
Potential Compounding Over Time
Money invested in an IRA has the potential to compound over time. Known as compounding returns, this happens when investment earnings generate their own earnings.
Roth and Traditional IRA Tax Options
Traditional and Roth IRAs offer different tax treatments, as described above. This gives retirement savers the flexibility to choose the account type that may fit their current and expected future tax situation.
Catch-Up Contributions
People aged 50 and older can generally contribute additional funds to an IRA through catch-up contributions to help them save more for retirement.
IRA Rules and Potential Drawbacks
Along with their benefits, IRAs also come with rules, limitations, and possible disadvantages. These include:
Contribution Limits
IRA contribution limits are substantially lower than 401(k) contribution limits. If you want to save more for retirement, you may want to use an IRA along with an employer-sponsored plan, if possible.
Income and Deduction Limits
Roth IRA contributions are subject to income limits. Traditional IRA contributions don’t have income requirements, but the ability to deduct contributions may be limited by income, filing status, and workplace retirement plan coverage.
Early Withdrawal Rules
IRAs are designed to help people save for retirement. If you withdraw money before age 59 ½, you may owe taxes and a 10% penalty unless an exception applies. Roth IRA contributions can typically be withdrawn tax- and penalty-free at any time, but Roth earnings are subject to early withdrawal penalties and taxes.
Required Minimum Distributions
Traditional IRAs generally require an account owner to take RMDs beginning at age 73. Roth IRAs do not impose RMDs for the original account owner.
Investment Risk
All investments involve risk, including investments in an IRA. A person can lose money depending on how their IRA is invested and market performance.
Rollover and Conversion Complexity
Rollovers and Roth conversions can have tax consequences. If you’re moving money between accounts or converting pre-tax money to an after-tax Roth account, it may be helpful to consult a tax professional.
IRA vs. 401(k): What’s the Difference?
IRAs and 401(k)s are both designed to help individuals save for retirement, but one is a workplace plan and the other isn’t. They also function differently. Here is a side-by-side comparison of them.
| IRA | 401(k) | |
|---|---|---|
| Opened by | An individual | Employer-sponsored |
| Contribution limits | Lower annual limits | Significantly higher annual limits |
| Employer match | None | Employer match may be available |
| Investment options | Typically a broad range of options, depending on the provider | Generally limited to a smaller menu of plan options |
| Tax treatment | Traditional and Roth options with corresponding tax advantages are available | Traditional and Roth options may be available, depending on the plan |
| Good to know | Can supplement a workplace savings plan | May be worth prioritizing contributions to if an employer match is available |
If your employer offers a 401(k) match, contributing at least enough to receive the full match is worth considering before funding an IRA. Beyond that, an IRA may offer additional flexibility and investment choices for retirement savers.
Which Type of IRA May Be Right for You?
The right IRA typically depends on your income, employment status, tax situation, and retirement goals. Here are some general guidelines to explore.
| If you are … | Consider this type of IRA |
|---|---|
| Looking for a tax deduction now | Traditional IRA |
| Looking for tax-free withdrawals in retirement | Roth IRA |
| Self-employed or a small business owner | SEP IRA or SIMPLE IRA |
| Moving money from a previous employer’s plan | Rollover IRA |
| Opening an account for a minor with earned income | Custodial IRA |
| An IRA beneficiary | Inherited IRA |
For many individual savers, the main choice is between a Roth IRA and a traditional IRA. A Roth IRA may make sense if you expect to be in a higher tax bracket in retirement and want tax-free qualified withdrawals then. A traditional IRA may make sense if you want a possible tax deduction now and expect to be in a lower tax bracket in retirement.
When Is the IRA Contribution Deadline?
IRA contributions for a tax year are generally due by the federal tax filing deadline the following year. For example, 2025 IRA contributions were generally due by April 15, 2026. Contributions for 2026 are generally due by April 15, 2027.
This article is part of SoFi’s Retirement Planning Guide, our coverage of all the steps you need to create a successful retirement plan.
How to Open an IRA
Opening an IRA is fairly simple and straightforward. Here are the six basic steps involved.
1. Choose the Type of IRA
Decide whether a traditional IRA, Roth IRA, or another type best fits your situation.
2. Choose an IRA Provider
You can open an IRA through a brokerage, bank, online bank, or other financial institution. Compare fees, investment choices, account minimums, digital tools, and customer support options.
3. Complete the Application
You’ll typically need to provide personal information, such as your name, address, date of birth, Social Security number or taxpayer identification number (TIN), and employment information.
4. Fund the Account
You can fund an IRA with contributions or a rollover from an eligible retirement account, for example. Contribution and rollover rules differ, so make sure you understand which type of funding applies. Also, pay close attention to contribution limits to make sure you don’t exceed them.
5. Choose Investments
Once money is in the account, you can select investments. Your options typically depend on the provider and the type of IRA you opened.
6. Consider Recurring Contributions
You don’t have to make the full annual IRA contribution limit all at once. Setting up recurring automatic contributions can help make saving for retirement easier and more consistent.
IRA Withdrawal Rules to Know
IRA withdrawal rules vary by account type.
With a Roth IRA, contributions can generally be withdrawn tax- and penalty-free at any time. However, to withdraw earnings tax-free, the withdrawal typically must be qualified (the Roth IRA must have been open for at least five years and you are aged 59 ½ or older). Withdrawals taken early are subject to taxes and a 10% penalty.
With a traditional IRA, withdrawals in retirement are generally taxed as ordinary income. If you take money out of the account before age 59 ½, you may also be subject to a 10% early withdrawal penalty along with taxes.
SEP IRAS typically follow traditional IRA withdrawal rules. So do SIMPLE IRAs, though there can be a higher penalty for certain withdrawals. Consult your plan documents or plan administrator to learn the specifics.
IRA withdrawal rules can be complex, so it may be worth speaking with a tax professional if you are considering an early withdrawal.
The Takeaway
An IRA is a tax-advantaged retirement account that can help individuals save and invest for the future. Traditional and Roth IRAs are the most common types of IRA for individuals to open, while SEP and SIMPLE IRAs are often used by self-employed people and small business owners. The right IRA depends on your circumstances, income, tax situation, retirement goals, and whether you’d like a potential tax break now or tax-free qualified withdrawals in retirement.
Before opening an IRA, review the contribution limits, earned-income requirements, investment options, withdrawal rules, and potential tax consequences.
Prepare for your retirement with an individual retirement account (IRA). It’s easy to get started when you open a traditional or Roth IRA with SoFi. Whether you prefer a hands-on self-directed IRA through SoFi Securities or an automated robo IRA with SoFi Wealth, you can build a portfolio to help support your long-term goals while gaining access to tax-advantaged savings strategies.
Help build your nest egg with a SoFi IRA.
FAQ
What does IRA stand for?
IRA stands for “individual retirement account” or “individual retirement arrangement.” Most people refer to it as an individual retirement account.
Is an IRA an investment or an account?
An IRA is an account that can hold investments. Depending on the IRA provider, investments may include stocks, bonds, mutual funds, ETFs, CDs, and more.
Can you lose money in an IRA?
Yes. Investing always involves risk. Investments within an IRA can rise or fall in value, so you can lose money depending on how the account is invested.
How much money do you need to start an IRA?
Some IRA providers have no minimum amount required to open an IRA, while others may require a small minimum deposit. You do not have to contribute the full annual contribution limit at once.
Can I have both an IRA and a 401(k)?
Yes, you can have both a Roth IRA and a 401(k) as long as you meet the Roth IRA eligibility requirements. IRA contribution limits are separate from contribution limits to 401(k)s.
Is a Roth IRA or traditional IRA better?
It depends on your specific situation. A Roth IRA may make sense if you expect to be in a higher tax bracket in retirement. With a Roth, you make contributions with after-tax dollars and withdraw the money tax-free in retirement. A traditional IRA may make sense if you expect to be in a lower tax bracket in retirement because you’ll pay taxes on withdrawals then. You can take deductions on your traditional IRA contributions upfront, which could help lower your taxable income for the year.
Can I borrow from an IRA?
No, you cannot borrow from an IRA. IRAs do not allow loans. However, if you have a Roth IRA, you can typically withdraw your contributions tax- and penalty-free. Another option to consider: There are also tax- and penalty-free withdrawals allowed from traditional and Roth IRAs in certain situations, such as for a first home purchase up to a specific limit.
When can I withdraw money from an IRA?
Penalty- and tax-free withdrawals from an IRA generally begin at age 59 ½, though exceptions may apply. With a Roth IRA, contributions can typically be withdrawn any time without taxes or penalties, but earnings are subject to early withdrawal taxes and penalties.
What is the IRA contribution limit for 2026?
For 2026, the IRA contribution limit is $7,500, or $8,600 if you’re aged 50 or older.
What is the IRA contribution limit for 2025?
For 2025, the IRA contribution limit is $7,000, or $8,000 if you’re aged 50 or older.
Can I open an IRA if I’m self-employed?
Yes. Along with traditional and Roth IRAs, those who are self-employed can also open IRAs specifically designed for the self-employed, such as SEP IRAs and SIMPLE IRAs.
Do IRAs have required minimum distributions?
Traditional IRAs generally have required minimum distributions (RMDs) beginning at age 73. Roth IRAs do not have RMDs for the original account owner.
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