Bottom Line Up Front
- An IRA is a savings account that comes with certain special tax advantages to encourage people to save for retirement.
- The difference between IRAs and 401(k)s is that IRAs are retirement accounts opened by individuals and 401(k)s are employer-sponsored plans.
- Except for certain circumstances, you’ll generally have to be at least 59½ to be able to withdraw funds without penalty from your IRA.
Most of us know that one of the keys to a secure financial future is to have a retirement savings account, but many aren’t sure where to begin. Members often ask us about the different types, how they work and how to choose the right one. Here are answers to some of the questions we hear the most.
What’s an IRA?
An IRA (“individual retirement account” or “individual retirement arrangement”) is a special savings account that automatically comes with certain special tax advantages to encourage people to save for retirement. Which ones you’ll enjoy will depend on the type of IRA you choose.
What’s the Difference Between an IRA and a 401(k)?
As the name implies, an IRA is opened by an individual. A 401(k), on the other hand, is an employer-sponsored retirement plan. It allows employees to have money automatically deducted from their paychecks and put into their tax-advantaged 401(k) accounts. Employers can also match some or all of these contributions.
Other examples of employer-sponsored plans are:
- 403(b): offered by government or non-profit (tax exempt) organizations
- 457/457(b): offered by state and local governments and some nonprofits
- Thrift Savings Plans (TSPs): offered by the federal government and U.S. military
Are they all the same, or is there more than one kind of IRA?
Basically, there are 2 main types of IRAs:
- Traditional IRA. A traditional IRA is tax-deferred. That means you don’t have to pay tax on any interest or other gains until you start withdrawing the money at retirement (generally, no earlier than age 59½). At that time, distributions will be taxed at ordinary income tax rates.1
- Roth IRA. Contributions to a Roth IRA are taxed as ordinary income, but withdrawals are tax-free, provided you meet certain conditions (e.g., holding the account for at least 5 years and being at least age 59½ when you start distributions).1
In addition, Simplified Employee Pension (SEP) plans allow self-employed individuals and business owners to contribute to a retirement plan for themselves and their employees. The rules and contribution limits are different from those for traditional and Roth IRAs. You can find more information on SEP plans on the IRS website and a side-by-side comparison chart for all three types in our Understanding Your IRA Options article.
Who Is Eligible to Open an IRA? Can Anyone Open One?
- Traditional IRA. If you’re younger than 72 and you have taxable income, you or your spouse can contribute to a traditional IRA. How much of your contributions will be deductible will depend on your income and filing status.
- Roth IRA. Anyone with earned income under a certain limit, and his or her spouse, can open and contribute to a Roth IRA. There’s no age restriction.
How Much Does It Cost to Open an IRA?
Most of the time, there are no account fees or minimums associated with opening an IRA. So, you can get started without having to contribute right away. However, some brokers or financial institutions do assess some charges or have limits. Account maintenance, brokerage commissions and other related fees vary by company and retirement savings options.
How Much Can I Contribute to an IRA?
According to the IRS, the current limit for all your IRAs (traditional and Roth) is $6,000 or your earned income, whichever is less. This amount is indexed to inflation each year. That means that there’s an automatic cost-of-living adjustment built into what is allowed, based on inflation.
Those aged 50 and older may make an additional $1,000 catch-up contribution or up to a total contribution of $7,000.
Which IRA Would be Best for Me?
It depends on a number of things, like whether you’d rather pay taxes now or when you withdraw your funds.
- Traditional IRA. If you’re eligible to deduct your contribution, a traditional IRA may be a good choice—especially if you think you’ll be in a lower tax bracket when you retire. Your IRA contribution is fully tax-deductible, up to the annual limit, if neither you nor your spouse has a retirement plan at work. If either of you has a retirement plan at work, deductibility is limited by income. Learn more on the IRS website.
- Roth IRA. Roth IRA contributions are never tax-deductible. However, if you’ve held the account for 5 years and are at least age 59½ when you start distributions, your withdrawals in retirement will be tax-free. A Roth IRA may be a better choice if you aren’t eligible to deduct your contribution or if you’d prefer to have tax-free income in retirement.
Can I Have a Traditional and a Roth IRA?
Yes, but the annual contribution limit explained above applies to the total of all the IRAs you own, not each IRA individually. For example, if you contribute the maximum amount to your traditional IRA, you won’t be able to contribute to your Roth IRA in that year.
Can I Have More Than One Roth IRA?
Yes, but if you contribute the maximum amount to your first Roth IRA, you won’t be able to contribute to your second Roth IRA in that year.
Do I Have to Start Taking Money Out of My IRA at a Certain Age?
- Traditional IRA. If your 70th birthday falls after July 1, 2019, you must start taking required minimum distributions (RMDs) at age 72 or face a heavy tax penalty.2
- Roth IRA. You actually don’t have to withdraw any money at all. However, if you want to, you can start withdrawing funds once you’ve reached age 59½ and have had your account for at least 5 years.
You also will need to take the RMD if you have a rollover, SEP, SIMPLE IRA and for most 401(k) or 403(b) accounts.
What’s a Rollover IRA?
A rollover IRA is an account set up to accept transferred funds from another IRA or an employer-sponsored retirement plan. It can be an excellent way to maintain the tax advantages of your retirement savings after you leave your job. Rollover IRAs aren’t bound to the annual contribution limit for IRAs. Any amount can be transferred (rolled over), as long as it comes from an eligible plan (401(k), 403(b), 457, TSP) or another IRA.
You should know, however, that there are some other limits. For example, you can’t have more than 1 rollover from the same IRA in a year. And, you can’t make a rollover from the IRA to which the money was transferred during the same time period.
Why Open an IRA if I Already Have a 401(k)?
Sometimes, an employer-sponsored plan may not be enough to cover your needs during retirement. An IRA can be a great way to supplement it. Not only does an IRA provide an opportunity to save more money for retirement, but you also may have access to a wider range of investments than what your employer-sponsored plan offers.
For example, you can put your money into insured IRA certificates or savings. Or, you could purchase stocks, bonds and/or mutual funds if you have a brokerage IRA, such as those available through Navy Federal Financial Group.3
Where Should I Open an IRA—With My Bank or Credit Union?
Typically, banks and credit unions offer more conservative options. These savings options, like certificates or certificates of deposit (CDs), are generally less risky and cater more for people near or in retirement. Before deciding to invest in one institution over another, it’s always smart to compare and do research first.
Ready to Get Started?
Ready to open an IRA? Visit our Retirement Savings Options page to see how.
1Premature withdrawals from either type of IRA will be taxed at ordinary income tax rates and are subject to a 10 percent IRS penalty.
2Failure to make RMDs may result in a tax penalty of 50 percent of the amount that should have been withdrawn but was not.
3Investments in stocks, bonds and mutual funds are not insured by any federal government agency, are not deposits of Navy Federal, and may lose value, including possible loss of principal amount invested.