Individual retirement accounts, or IRAs, are tax-advantaged accounts that allow you to save for retirement. There are two main types of IRAs: Roth IRAs and traditional IRAs.
Let’s look at what IRAs are and how they work.
How do IRAs work?
IRAs offer another way to save for retirement. You can have an IRA in addition to an employer-sponsored retirement account, such as a 401(k). They can be particularly useful if you’re self-employed or not covered by an employer.
You can invest the funds you contribute to your IRA in different assets, including CDs, mutual funds, stocks and bonds. You can usually choose a target-date retirement fund or decide how to invest your money on your own. IRAs generally have a wide range of investment options compared to other types of retirement accounts.
Roth and traditional IRAs have different rules, but, in general, you deposit money in the account, and it grows tax-free or tax-deferred until you make withdrawals.
Tax benefits
IRAs allow you to grow money tax-free or tax-deferred.
With Roth IRAs, you contribute post-tax income and can withdraw the earnings tax- and penalty-free after age 59 1/2 if it’s been at least 5 years since your first contribution.
With traditional IRAs, your contributions can be tax-deductible (depending on your income and whether you or your spouse are covered by a retirement plan at work), and the money grows tax-deferred. You can make withdrawals after age 59 1/2 without incurring a tax penalty, and these distributions will be includible in your taxable income.
Contribution limits
IRAs have annual contribution limits. For 2024, the contribution limit for all contributions across traditional and Roth IRAs is $7,000, or $8,000 if you're 50 or older.
Your income and whether you or your spouse are covered by a retirement plan at work can also affect your contribution limits and how much you’re able to deduct on your taxes.
Required minimum distributions
IRAs can come with required minimum distributions, or RMDs. This means you must withdraw money after a certain age or the amount not withdrawn is subject to a tax penalty. Roth IRAs do not come with RMDs for the original account owner.
Types of IRAs
Let’s look at the rules for traditional and Roth IRAs, as well as several other types of IRAs.
Traditional IRAs
You can contribute to a traditional IRA regardless of your income, and contributions may be tax-deductible. However, the amount you can deduct can decrease and eventually phase out at higher incomes. This amount can also change depending on whether you or your spouse are covered by a retirement plan at work.
You can withdraw money from a traditional IRA after age 59 1/2 without incurring a tax penalty. Traditional IRA distributions are part of your taxable income.
Contribution limits: For 2024, your contributions cannot exceed $7,000 (or $8,000 if you're 50 or older) across your traditional and Roth IRAs. If your taxable compensation is less than this amount, your contribution limit is your taxable compensation for the year.
RMDs: You must begin taking distributions from your traditional IRA at age 72 (73 if you reached age 72 in 2023 or later).
Roth IRAs
Roth IRAs are funded with post-tax income. The money then grows tax-free, and earnings can be withdrawn tax-free after age 59 1/2 if it’s been at least 5 years since your first contribution. You can always withdraw your original contribution tax- and penalty-free.
Contribution limits: Across your traditional and Roth IRAs, your contributions can’t be more than $7,000 (or $8,000 if you're 50 or older) for 2024. If your taxable compensation is less than this amount, your contribution limit is your taxable compensation for the year.
Roth IRAs have income eligibility limits. Depending on how much you make, you may be able to contribute a reduced amount, or you may not be able to contribute at all.
RMDs: For Roth IRAs, the original account owner does not have to make RMDs. However, if you inherit a Roth IRA, RMD rules can apply.
Rollover IRAs
Rollover IRAs let you move (or “roll over”) assets from your old employer-sponsored retirement account into an IRA. With a rollover IRA, there’s no limit on the amount of money you can transfer. However, if you continue contributing to your IRA, future contribution limits apply.
You can roll your employer-sponsored retirement account into a traditional or Roth IRA. Just keep in mind that if you roll over money from a tax-deferred account like a 401(k) into a Roth IRA, you will likely be responsible for paying taxes on that money.
SEP IRAs
Simplified employee pension (SEP) IRAs allow employers to contribute to IRAs on behalf of their employees. Businesses of any size can set up SEP Plans.
Withdrawals from Traditional SEP IRAs are part of your taxable income. Like traditional IRAs, you can withdraw from your Traditional SEP IRA without a tax penalty after the age of 59 1/2. For Roth SEP IRAs, you may take out contributions at any point without tax or penalty since you’ve already paid tax on the money. But any earnings withdrawn before the age of 59 1/2 are subject to a 10 percent tax penalty.
Contribution limits: Employers can contribute up to 25 percent of each employee's pay or $69,000 for 2024 (whichever amount is lower).
RMDs: You must begin taking distributions from your Traditional SEP IRA at age 72 (73 if you reached age 72 in 2023 or later).
SIMPLE IRAs
A SIMPLE IRA (Savings Incentive Match Plan for Employees) allows both employees and employers to contribute to an employee’s IRA. SIMPLE IRAs are generally available to small businesses, typically with fewer than 100 employees.
SIMPLE IRA withdrawals are part of your taxable income. You can withdraw money from your SIMPLE IRA without incurring a tax penalty after age 59 1/2 and after you’ve had the account for 2 years.
Contribution limits: For 2024, employees can contribute up to $16,000 to their SIMPLE IRAs. Employer contributions are mandatory. Employers can either make matching contributions of up to 3% of the employee’s compensation or non-elective contributions of 2% of the employee’s salary.
RMDs: You must begin taking distributions from your SIMPLE IRA at age 72 (73 if you reached age 72 in 2023 or later).
Benefits, drawbacks and risks of an IRA
IRAs come with quite a few benefits. They offer tax benefits and can be a great way to save for retirement if you’re self-employed or if your employer doesn’t offer a retirement account. IRAs can also help you save more for retirement, even if you already have access to an employer-sponsored retirement account. IRAs also typically offer a variety of investment options.
Drawbacks to IRAs can include RMDs, if they apply, as well as tax penalties if you withdraw money too early. IRAs allow you to invest your money, and all investments come with some level of risk.
Is an IRA right for you?
Whether an IRA is right for you will depend on your financial situation. Your income, age and whether you or your spouse have access to an employer-sponsored retirement plan can affect how much you can contribute to a plan or deduct from your taxes.
When deciding between a traditional and Roth IRA, it’s important to consider your eligibility, contribution limits and how much money you’ll be able to deduct on your taxes, if any. Taxes work differently for Roth and traditional IRAs. It’s important to understand how taxes work for both types of accounts and consider your anticipated income in retirement.
This article is for general educational purposes. It is not intended to provide financial advice. It also is not intended to describe any Citi product or service. You should refer to the terms and conditions financial institutions provide for various products. Please be sure to consult your tax advisor for your own situation, including contribution limits and deductibility. Citi is not a tax advisor.
