What is an IRA?
Retirement accounts can be great. But they do have some limitations. If you are fortunate, your employer may offer a 401(k) plan, which typically comes with higher contribution limits and, often, the added benefit of an employer match.
But what if you do not have access to a 401(k)?
Or what if you are already maxing out your contributions and want to save even more for the future?
Well, in this case, you can open an Individual Retirement Account or an IRA, as it is popularly known. Unlike a 401(k), an IRA is something you open on your own through a bank, brokerage, or online investing platform. An IRA typically comes with lower annual contribution limits than a 401(k), but it gives you full control over where your money is invested. You can choose from a wide range of options, depending on your risk tolerance and retirement goals. You can also open an IRA even if you already have a 401(k). This can offer additional tax benefits and help you diversify your investments.
Before opening an IRA, though, you need to take the time to understand what an IRA is, how it works, the different types available, contribution limits, tax benefits, and withdrawal requirements. There is a lot to figure out when it comes to retirement accounts, but this article pulls everything together in one place to make it easier for you.
Table of Contents
What is an IRA account, and how does it work?
An IRA is a personal retirement savings account that comes with several attractive tax benefits. It is a dedicated savings account designed for retirement. However, it can be used for other long-term purposes, too. It grows in a tax-efficient way. You do not need an employer to set one up. You can open an IRA on your own through a bank, brokerage, mutual fund company, or even a life insurance company.
So how does it work?
Each year, you can contribute up to a certain limit set by the Internal Revenue Service (IRS). The money you put in can be invested in all sorts of instruments, such as stocks, bonds, mutual funds, and even Certificates of Deposits (CDs), depending on where you open your account. Over time, your contributions and earnings can grow into a serious retirement nest egg.
Now, an IRA is quite an interesting account. There is not just one kind of IRA. The two most common are Traditional and Roth IRAs. With a Traditional IRA, your contributions may be tax-deductible. Roth IRAs work the other way around. There are other types too, like Simplified Employee Pension (SEP) IRAs, Savings Incentive Match Plan for Employees (SIMPLE) IRAs, and even inherited or custodial IRAs for special situations.
The IRS sets annual contribution limits for IRAs, which apply to both Traditional and Roth IRAs combined. For 2025, if you are under the age of 50, you can contribute up to $7,000 across all your IRAs. If you are 50 or older, you get the advantage of making a catch-up contribution, which lets you put in an extra $1,000. This brings your total annual limit to $8,000 and can help you when you are closer to retirement. Please note that you can only contribute up to your earned income for the year.
Types of IRAs
Now that you know what an IRA account is, let’s understand its many types so that you can select the right one. The two most common IRAs you will hear about are the Traditional IRA and the Roth IRA.
Let’s start with the Traditional IRA
A Traditional IRA is pretty straightforward. You put money in, potentially get a tax break for doing so, and then let it grow tax-deferred until you take it out in retirement. You do not pay capital gains tax or tax on dividends as your investments grow. The contributions you make to a Traditional IRA may be fully or partially deductible depending on your income and tax-filing status. In simple terms, you can lower your taxable income for the year you contribute.
Anyone with earned income can contribute to a Traditional IRA. There is no maximum income limit that excludes you. And thanks to the SECURE Act of 2019, there is no longer an age cap on contributions either. As long as you have eligible earned income, like wages, salaries, self-employment income, and the like, you can keep contributing even past the age of 70. So, the savings spree never has to end.
Of course, there are rules for when you can withdraw the money. You can start taking penalty-free withdrawals at age 59½. Before that, any withdrawal is generally hit with two things – income tax because you deferred paying it earlier, and a 10% early withdrawal penalty.
That said, there are a few exceptions that allow you to tap your Traditional IRA without incurring the penalty. For instance, you can use up to $10,000 in lifetime withdrawals for buying or building your first home. You can also withdraw money without having to pay a penalty if you become disabled, if your beneficiary receives it after your death, or if you need it for certain qualified expenses, such as unreimbursed medical bills, health insurance premiums after losing a job, higher education costs, or expenses related to having or adopting a child.
Once you turn 73, you have to start taking Required Minimum Distributions (RMDs) each year, as of 2025. These withdrawals make sure that you eventually pay taxes on the money that you had deferred for so long. Your first RMD must be taken by April 1 of the year after you turn 73, and then by December 31 every year after that. If you do not take them on time, the penalty can be up to 25% of the amount you should have withdrawn.
Time to get to know a Roth IRA
With a Roth IRA, you put in money that you have already paid taxes on. There is no tax deduction for your contributions in the year you make them, but your money grows tax-free, and when you withdraw it in retirement, you do not owe taxes as long as you follow the rules.
The rules for Roth IRAs are pretty flexible. You can keep contributing as long as you have earned income, even past age 70½. You can also leave the money in your Roth IRA for as long as you want, as there are no RMDs during your lifetime. So, if you don’t need the money right away, you can let it continue to grow tax-free for as long as you live or even pass it down to your heirs.
Another feature that makes Roth IRAs unique is the accessibility of your contributions. You can withdraw the money you put in at any time without paying taxes or penalties, even if you are younger than 59½.
Please note that while you can withdraw your contributions at any time, you must wait until you are at least 59½ and the account has been open for at least five years to withdraw the investment earnings tax-free.
You also have plenty of investment options within a Roth IRA. You can choose from mutual funds, stocks, bonds, CDs, or even money market funds. What you can’t do is invest in collectibles, life insurance, most coins, or S-corp stock. Those are off-limits under IRS rules.
An important thing to know about Roth IRAs is that they are subject to income limits. If you earn too much, you may not be able to contribute directly. For 2025:
- If you are married filing jointly, you can contribute the full amount if your combined income is under $236,000.
- You can make a partial contribution if your income is between $236,000 and $246,000.
- Single filers can contribute the full amount if they earn less than $150,000, with partial contributions allowed up to $165,000.
Now, let’s define IRAs other than these two popular ones
1. SEP IRA
A SEP IRA is an excellent option if you are self-employed or run a small business. Unlike a traditional IRA, where you make contributions yourself, a SEP IRA is funded by the employer. So, in this case, it is similar to a 401(k) account. If you own a business, you can set one up and make contributions for yourself and any eligible employees.
The contributions made to a SEP IRA are tax-deductible for the business, which helps lower taxable income. Employees also get the benefit of receiving contributions directly into their SEP IRA accounts, without having to put in any of their own money. And because contributions are immediately 100% vested, the money belongs to the employee right away.
Another advantage of a SEP IRA is its higher contribution limits compared to a regular IRA. In 2025, you can contribute up to the lesser of 25% of an employee’s total compensation, up to $70,000. If you are self-employed, you can contribute up to 25% of your net earnings after subtracting the contribution itself. To participate, employees generally:
- Must be at least 21 years old
- Have worked for the business in three of the last five years
- Have earned at least $750 in compensation during the year
The investment choices for SEP IRAs are the same as traditional IRAs, so that you can invest in stocks, bonds, and other investment instruments. Distributions from a SEP IRA are taxed like those from a traditional IRA, and the withdrawals are treated as ordinary income. Taking money out before age 59½ will usually trigger a 10% early withdrawal penalty unless you qualify for an exception.
2. SIMPLE IRA
A SIMPLE IRA is a retirement savings plan designed for small businesses with 100 or fewer employees. It allows both employers and employees to contribute to traditional IRAs set up for employees.
Employers must choose one of the following two options each year:
- Non-elective contribution: 2% of each eligible employee’s compensation, whether or not the employee contributes.
- Matching contribution: Dollar-for-dollar match of employee contributions, up to 3% of the employee’s compensation.
Employee contributions must follow these rules as of 2025:
The deferral limit is $16,500
- The catch-up contribution limit for ages 50 to 59 and 64+ is $3,500.
- The SECURE Act 2.0 introduced higher catch-up contribution limits for participants aged 60 to 63. Starting in 2025, the catch-up contribution is the greater of $5,000 or 150% of the regular age 50 catch-up contribution limit for SIMPLE IRA plans.
Additional options under SECURE Act 2.0:
- Employers may now also make additional non-elective contributions of up to 10% of compensation or $5,000, whichever is less.
To establish a SIMPLE IRA, the employer must:
- Have 100 or fewer employees
- Be a small business owner, self-employed, or a sole proprietor
Additionally, to participate in the plan, employees must:
- Have earned at least $5,000 in compensation in any two previous calendar years.
- Be expected to earn at least $5,000 in the current year.
SIMPLE IRAs also follow some rollover rules. If you have a SIMPLE IRA, you must wait two years from the date it was first established before you can do a tax-free rollover into another plan, like a traditional IRA or 401(k). After two years, you may also roll over funds to a Roth account, but you will need to include any previously untaxed amounts in your taxable income.
3. Custodial IRA
A custodial IRA is a retirement account that parents or guardians can open for a child under the age of 18 who has earned income. It can be set up as either a Traditional IRA or a Roth IRA. The money from a custodial IRA can go toward college expenses, a first home, or even retirement, no matter how far it may seem right now.
To be eligible, the child must have earned income during the year. This income does not have to come from a formal job, which kids are unlikely to have anyway. It can come from odd jobs and part-time gigs, such as pet sitting, lawn mowing, acting in a commercial, or other self-employment activities.
Contributions can be made up to the lesser of the child’s total earned income or the annual IRA contribution limit. Parents or guardians can contribute on behalf of the child, as long as the amount matches the child’s earned income.
A custodial Roth IRA is especially popular because contributions are made with after-tax dollars, and qualified withdrawals later in life are completely tax-free. As with other IRAs, withdrawals of earnings before age 59½ generally trigger both income taxes and a 10% penalty, unless an exception applies. Some of the most useful exceptions include using the money for qualified education expenses or for a first-time home purchase. After age 59½, withdrawals follow the usual rules.
4. Inherited IRA
An inherited IRA, sometimes referred to as a beneficiary IRA, is established when you inherit someone else’s IRA after their passing. Unlike a regular IRA, you can’t make any additional contributions to an inherited IRA. You can, however, manage and distribute the funds you have inherited.
The good news is that the money can stay tax-deferred until you start taking withdrawals. And unlike with a regular IRA, you can usually access the money right away without paying the usual 10% early withdrawal penalty.
There are some essential rules you need to follow. In most cases, if you are a designated beneficiary, you must empty the account by the end of the 10th year after the original owner’s death.
If you inherit an IRA from a spouse, you have more choices. You can roll over all or part of the inherited IRA into your own IRA and treat it as if it were yours. You have 60 days from receiving a distribution to roll it over into your own IRA, as long as the money is not an RMD.
If you are a non-spouse beneficiary, the rules are stricter. You can’t roll the funds into your own IRA or make additional contributions to the inherited account. You also can’t just leave the money sitting in the original owner’s IRA indefinitely. The account must still be distributed in accordance with the 10-year rule.
What IRA retirement account makes sense for you?
Your income level, your tax bracket, your employment status, and even your age all play a role in deciding which IRA is the best fit. And of course, eligibility is key. Your income has to fall within certain limits to contribute to certain IRAs. Because there are so many factors to consider, like taxes, contribution limits, penalties, and long-term growth, it is important to talk to a financial advisor before making a decision.
Our free advisor match tool can help you connect with a professional who can answer your questions about what an IRA investment is, how to open an account, IRA contribution limits, tax benefits, withdrawal rules, and more.
For further information on creating a suitable retirement plan for your unique financial requirements, visit Dash Investments or email me directly at dash@dashinvestments.com.
About Dash Investments
Dash Investments is privately owned by Jonathan Dash and is an independent investment advisory firm, managing private client accounts for individuals and families across America. As a Registered Investment Advisor (RIA) firm with the SEC, they are fiduciaries who put clients’ interests ahead of everything else.
Dash Investments offers a full range of investment advisory and financial services, which are tailored to each client’s unique needs providing institutional-caliber money management services that are based upon a solid, proven research approach. Additionally, each client receives comprehensive financial planning to ensure they are moving toward their financial goals. CEO & Chief Investment Officer Jonathan Dash has been covered in major business publications such as Barron’s, The Wall Street Journal, and The New York Times as a leader in the investment industry with a track record of creating value for his firm’s clients.
Other posts from Jonathan Dash
