WHAT are IRA retirement accounts?
A century ago, most working Americans didn’t think about investing for retirement. Instead, they were often covered by pensions or other employer sponsored plans, who took care of investing for them.
Those kinds of plans steadily dropped in popularity, eventually leaving most workers to invest on their own. In 1974, Congress passed a law creating the “Individual Retirement Arrangement,” or IRA. In 1997, they passed legislation creating the Roth IRA, a second type of individual retirement vehicle. There are also others (e.g. SEP IRAs, SIMPLE IRAs), but let’s focus on the first two for now.
In both traditional and Roth IRAs, the participants own the accounts, not the employer. Understanding how they work is an important part of retirement planning.
HOW do they work?
WHY is this concept important?
The tax advantages of these accounts can be powerful. In a normal taxable account, capital gains and income from interest or dividends are typically taxed anywhere from 15-37% depending on your income. And that’s just at the Federal level – when adding in state and local taxes, some people pay 50% or more.
This creates a significant drag on your portfolio growth rate. By bypassing these taxes in a retirement account, your money can accumulate faster and grow to a much larger balance over time. There are also tax advantages at the contribution or withdrawal stage, which can be used for overall financial planning purposes.
WHO are retirement accounts for?
Starting in 2023, workers under 50 can contribute up to $6,500 per year to all of their traditional and Roth IRAs. Those who are over 50 can contribute $7,500. Above 70.5, there is no contribution limit.
Traditional IRAs
| Contributions | Growth & Income |
| Pre-tax |
Tax-free Withdrawals Taxed |
Roth IRAs
| Contributions | Growth & Income |
| Post-tax |
Tax-free Withdrawals Tax-Free |
A few important caveats:
- There are income limitations for both types of accounts. Roth limits can be found here, and traditional limits here and here.
- In a traditional IRA, you must begin taking minimum distributions from the account in the year after you turn 72 (more here).
- Both types of IRAs are intended, as the
In both traditional and Roth IRAs, growth and income are completely tax-free.
The primary difference is contributions and withdrawals. In a traditional IRA, you receive a tax break on contributions but make up for this by paying tax once you start taking withdrawals. Roth IRAs are essentially the opposite.
As the name implies, for retirement. Taking withdrawals before age 59.5 can result in significant penalties.