Many Americans are lucky enough to have a retirement savings plan through their employers. If you don't have that option, an Individual Retirement Account — or IRA — allows anyone with earned income to save for retirement. And if you're self-employed, you can use an IRA to create your own retirement plan. In addition, there are special rules that may allow a stay-at-home spouse to contribute to one as well.
What are IRAs exactly?
First, an IRA isn't an investment itself. Think of it as a container or basket where you can put all kinds of investments — such as share certificates, mutual funds, stocks, bonds, etc. — you get to decide what to invest in.
There are two kinds of IRAs. The first is a Traditional IRA, which is often touted come tax time, because it has the potential to reduce what you owe on your income taxes. The beauty of an IRA is it acts like a savings account with tax breaks, because your contributions reduce your taxable income, and your contributions are able to grow tax-deferred until you start withdrawing it come retirement time. However, because your contributions are earmarked for retirement, you'll incur early withdrawal penalties in addition to taxes if you withdraw funds before age 59 ½.
The second kind is a Roth IRA, and it uses after-tax contributions, allowing your contributions to grow tax-free. Your withdrawals can be tax-free too, if you follow the rules. While a Roth won't help to reduce your taxable income at tax time since you are using after-tax dollars, you'll still get the benefit of adding to your retirement savings tax free and have more flexibility to withdraw your contributions at any time, without penalties. However, earnings you make on your investment can only be withdrawn when you are age 59 ½ or older and have had your Roth for five years or longer, otherwise, you will incur taxes and penalties.
How much can I contribute to an IRA?
According to the IRS, for the 2023 tax year you can contribute up to a maximum of $6,500 if you're under age 50, and if you're 50 or older — $7,500. The amounts above are maximum annual limits for combined total contributions to both Traditional and Roth IRAs. You can also contribute to both traditional and Roth IRAs after age 70 ½ as long as you have earned income.
This article is for information purposes only. Please consult a qualified tax professional for tax advice on your specific situation.