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In the U.S., an Individual Retirement Account (IRA) is a retirement savings tool that offers tax advantages, as outlined in IRS Publication 590. It’s essentially a government-backed way to encourage individuals to invest for their retirement by offering special tax treatment.

There are several types of IRAs, but the most commonly used are Traditional IRAs and Roth IRAs. With a Roth IRA, you contribute money that’s already been taxed, but your withdrawals in retirement are completely tax-free. In contrast, contributions to a Traditional IRA are usually tax-deductible, but you’ll pay taxes on withdrawals during retirement.

Because many people expect to earn less in retirement than during their working years, they may fall into a lower tax bracket. This can make Traditional IRAs more financially attractive, as taxes are deferred until retirement. Both Traditional and Roth IRAs allow your investments to grow tax-advantaged, helping you accumulate more wealth than regular taxable accounts.

There are also SEP IRAs, commonly used by self-employed individuals and small business owners, and SIMPLE IRAs, which are ideal for small businesses with fewer than 100 employees.

Traditional IRA

A Traditional IRA is the most widely used type of IRA. Contributions may be tax-deductible depending on your income and filing status, and the money grows tax-deferred until you start taking distributions.

Withdrawals are taxed as income and are allowed penalty-free after age 59½. If you take money out before that age, you’ll likely face a 10% penalty unless you qualify for an exemption. You must begin taking required minimum distributions (RMDs) starting at age 73. Most individuals are eligible to open a Traditional IRA.

Roth IRA

A Roth IRA is funded with after-tax dollars, meaning you pay taxes on the money before contributing it. However, your investment grows tax-free, and qualified withdrawals in retirement are also tax-free.

Once you reach age 59½, you can take out money without penalties, and unlike Traditional IRAs, there are no required minimum distributions during your lifetime. This means your funds can continue to grow tax-free as long as you live. For calculations and insights tailored to Roth IRAs, visit our Roth IRA Calculator.

SEP IRA

A Simplified Employee Pension (SEP) IRA is a retirement plan typically used by self-employed professionals and small businesses. Employers contribute to their employees’ SEP IRA accounts, and the contributions are treated as business expenses.

SEP IRAs follow similar tax rules to Traditional IRAs but offer much higher contribution limits. For 2025, employers can contribute up to 25% of an employee’s compensation, or $70,000—whichever is lower. All contributions are fully vested immediately. However, catch-up contributions for those aged 50 and older are not allowed. All eligible employees must receive the same percentage contribution.

SIMPLE IRA

The Savings Incentive Match Plan for Employees (SIMPLE IRA) is another retirement option designed for small businesses. It has lower administrative costs compared to 401(k) plans and is easy to manage.

Employers can either match employee contributions up to 3% of their salary or contribute a flat 2% for all employees, regardless of participation. For 2025, employees can contribute up to $16,500, with an additional $3,500 catch-up contribution for those 50 or older, and $5,250 for those aged 60 to 63. However, the combined limit across multiple employer-sponsored plans is $23,500.

Note: Early withdrawals from SIMPLE IRAs within the first two years of participation come with a steep 25% penalty, which drops to 10% thereafter.

IRA Rollovers

You can move funds from employer-sponsored plans like 401(k), 403(b), SIMPLE IRA, or SEP IRA into a Traditional IRA through a process called a rollover. This allows you to consolidate your retirement savings while maintaining tax-deferred status—no taxes are due if done properly.

However, you must still report the rollover using IRS Forms 1099-R (distribution) and 5498 (contribution). Keep in mind that Traditional and Roth IRA funds must remain in separate accounts, even after rollovers. Some people may also opt to keep funds in a former employer’s plan or roll them into a new employer’s plan. Cashing out is also an option, though it usually triggers taxes and early withdrawal penalties.

IRA vs. 401(k)

Traditional IRAs and 401(k) plans are both tax-advantaged retirement accounts, but they have key differences.

While both allow for pre-tax contributions and tax-deferred growth, 401(k) plans typically offer higher contribution limits and employer matching. In 2025, individuals can contribute up to $23,500 to a 401(k), plus $7,000 to a Traditional IRA ($8,000 if over age 50). However, high-income earners may have restrictions on IRA deductions.

401(k) plans are employer-sponsored and may have limited investment options and higher administrative fees. Traditional IRAs are opened individually and usually provide more diverse investment choices.

SEP and SIMPLE IRAs, unlike Traditional IRAs, can include employer contributions similar to a 401(k), making them ideal for small businesses without full 401(k) capabilities.

Investment Options Within IRAs

IRAs provide flexibility in how you invest your savings. Common investment choices include:

Active Stock Investing

This hands-on approach involves picking individual stocks or similar assets. While it can lead to high returns, it’s risky and better suited for experienced investors.

Mutual Funds and Index Funds

Mutual funds pool money from multiple investors and are professionally managed. Index funds, a type of mutual fund, track a specific market index like the S&P 500 or Dow Jones.

Both options offer long-term growth with lower risk and effort. They are among the most popular investment strategies for IRA holders due to their simplicity and diversification.

Robo-Advisors

These are automated investment platforms that create and manage personalized portfolios based on your financial goals. They are low-cost and user-friendly, making them ideal for beginners or hands-off investors.

Other Investment Types

Depending on the provider, you may also invest IRA funds in alternative assets such as:

• Precious metals

• Real estate investment trusts (REITs)

• Annuities

• Certificates of Deposit (CDs)

Self-Directed IRA (SD-IRA)

A Self-Directed IRA offers more control over your investment choices compared to Traditional or Roth IRAs. While the same rules apply regarding contributions and distributions, SD-IRAs let you invest in non-traditional assets like:

• Private businesses

• Real estate

• Tax liens

• Crowdfunding ventures

• Cryptocurrencies like Bitcoin

These accounts are generally available through specialized custodians and are subject to strict IRS oversight. They are recommended for experienced investors or those working with a financial advisor. Note that some investments—like life insurance, personal real estate, art, or collectibles—are prohibited in any IRA.

Conclusion

Whether you choose a Traditional IRA, Roth IRA, SEP, or SIMPLE plan, IRAs offer powerful tax benefits to help you build a secure financial future. Understanding how each type works—and choosing the right one based on your income, employment, and retirement goals—can help you make the most of your retirement savings strategy.