Understanding IRAs: The Complete Guide

Understanding IRAs: The Complete Guide

IRAs, or Individual Retirement Accounts, are essentially savings plans that come with considerable tax breaks. Do not confuse them with investments. Instead, think of them as a safety deposit box where you can store paper assets such as cash, mutual funds, stocks, bonds, etc.

Your employer does not provide IRAs - they offer what are called 401(k)s or other tax deferred accounts that work similar to IRAs. It is up to you to open an IRA on your own with the help of a bank, broker, or Robo-advisor.

There are various types of IRAs with different contribution and withdrawal policies. Before we jump on the different types, let us first understand IRAs in detail.

What Is An Individual Retirement Account (IRA)?

IRAs are tax-advantaged accounts that you can use to save and invest. 

Consider opening an IRA if any or all of these are true:

  • You have some spare cash you want to save for retirement (won’t need for a long time)
  • You want to invest and grow your money (and in the case of IRAs the money grows tax free)
  • You are interested in getting a tax break for making a contribution

These investments could consist of various financial instruments, such as bonds, mutual funds, stocks, and exchange-traded funds (EFTs).

Self-directed IRAs even allow the investors to make their own decisions, enabling them to pick from a wide range of investments. Such investments include private placements, real estate, and commodities.

Some popular picks for opening an IRA are banks, federally insured credit unions, and brokerage companies.

Purpose of an IRA

Your employer-sponsored savings plan might not be adequate to serve your future requirements. Therefore, investing in an IRA is a good idea. Think of it as a supplement to your savings in the employer-sponsored retirement plan.

Moreover, you get the advantage of potential tax-deferred or tax-free growth. You also get access to investment instruments that are not typically included in employer-provided plans.

Maximum Contribution & Catch-Up Rules

Regarding Traditional and Roth IRAs, you can contribute a maximum of $6,000 annually if you are younger than 50.

People aged 50 and older are allowed to make additional “catch-up” contributions. As of 2022, you can make an additional contribution of $1,000 to your IRA if you are over the age of 50. It means that you can contribute a total of $7,000 every year.

Types Of Individual Retirement Accounts

Let us briefly discuss the different kinds of IRAs.

1) Traditional IRA

Traditional IRAs are perhaps the most popular IRAs. The investment earnings in such accounts are untaxed, given the money remains within the protection of the account.

When you eventually withdraw the money in your retirement, you will have to pay the taxes on the withdrawal. This option is excellent for those that are currently in higher tax brackets than they expect to be in once they retire.

It is also a good choice for those who either don't have access to an employer-sponsored retirement plan or are ineligible to contribute.

Filing Status

2021 MAGI (Modified Adjusted Gross Income)


Single or head of household (and covered by a retirement plan at work)

$66,000 or less

Full deduction

More than $66,000 but less than $76,000

Partial deduction

$76,000 or more

No deduction

Married filing jointly (and covered by a retirement plan at work)

$105,000 or less

Full deduction

More than $105,000 but less than $125,000

Partial deduction

$125,000 or more

No deduction

Married filing jointly (spouse covered by a retirement plan at work)

$198,000 or less

Full deduction

More than $198,000 but less than $208,000

Partial deduction

$208,000 or more

No deduction

Married filing separately (you or spouse covered by a retirement plan at work)

Less than $10,000

Partial deduction

$10,000 or more

No deduction


2) Roth IRA

Roth accounts are for people that expect to be in a higher tax bracket during retirement since the withdrawals are tax-free. However, you do not receive a tax break while contributing because these contributions are not deductible.

If you feel like you will be dipping into your IRA savings before you retire, you should consider Roth IRAs. See our complete guide to Roth IRAs for more details.

Roth withdrawal rules are much more relaxed, as they allow tax-free and penalty-free withdrawals once you retire. Given this flexibility some people even count their Roth accounts as part of their emergency fund.


A simplified employee pension (SEP) IRA is set up and funded by your employer, who gets to reap the tax benefits for the initiative. In such IRAs, your earnings grow tax-free, but your retirement distributions are taxed.

The employers need to ensure equality by contributing to all employee accounts equally, on a percentage based on the salary. However, the contribution size can vary from year to year, based on the business's cash flow.

For self employed individuals, SEP IRAs can make a lot of sense as they are easy to setup and administer. See our related post for more on retirement accounts for self employed people.

4) Nondeductible IRA

Nondeductible IRAs are traditional IRAs where the contributions are not tax-deductible since they are made using after-tax money.

However, you still get the advantage of tax-deferred growth on earnings accumulated in the account. This type of account is suited for those that do not qualify to contribute to a Roth IRA or a deductible IRA.

The taxes during your retirement are due on the earnings growth you withdraw, not the principal amount.

5) Spousal IRA

Although IRS rules specify that you must have earned income to contribute to an IRA, married taxpayers have another way around this requirement.

If one of the two partners isn't working or earns a significantly lower income, both partners can contribute to their own IRAs. In such cases, couples are required to file a joint tax return and have taxable compensation for eligibility.

The IRA can be funded from either spouse's earnings. Hence, this method is a great choice for individuals that do not earn much or at all but are married to someone who has earned income.


The Savings Incentive Match Plan For Employees (SIMPLE) IRA is pretty similar to a workspace-sponsored 401(k). It is mainly meant for self-employed individuals and small companies.

In this IRA, the employee can contribute via salary deferral. In some cases, the plans even allow the employee to pick which financial institution they want to use for their account.

The employers are typically supposed to kick in up to 3% matching contribution of the employee's compensation or a fixed contribution of 2%.

7) Self-Directed IRA

Self-directed IRAs work similarly to the traditional and Roth IRAs, with the major difference being what goes into the account.

While all other kinds of IRAs restrict investments to common financial instruments such as bonds, stocks, and mutual funds, self-directed IRAs allow you to own real estate, gold, privately held companies, and other such assets.

Such accounts are the best option for experienced investors that are looking for alternative investment plans. There is great potential for returns in these accounts, but you must understand the risks before going forward.

Other Types Of Retirement Accounts that work like IRAs:

1) 401(k)

Similar to an IRA, a 401(k) plan is a retirement account offered through your employer. They are tax-advantaged retirement accounts with a defined contribution. The menu of available investments is determined by the plan, so you have limited flexibility in what you invest in. However, employers will often do a contribution match up to a percentage of your salary. Taking advantage of that is like getting a free bonus towards your retirement.

Investment earnings made from such an account are not taxed until employees withdraw the money, which is usually after retirement.

As of 2022, each spouse can annually contribute a maximum of $20,500, totaling $41,000 for the couple.

If both spouses are already 50 years old, each partner can make another $6,500 in catch-up contributions to their spouse’s account.

2) 457 and 403(b) plans

These work a lot like 401(k) plans but are only offered by government or educational institutions. They may offer additional perks like penalty free withdrawal upon separation. Review your retirement benefits package for details.

3) Solo 401(k)

A Solo 401(k) is a retirement account created for self-employed people or business owners who do not have full-time employees.

In such accounts, the individual can make contributions as both the employee (up to $20,500) and the employer (up to about 18.5% of profit). It is a great way of maximizing retirement contributions along with business deductions.

When you add the employee and employer contributions, you can contribute a maximum of $61,000 as of 2022!

Closing Thoughts

Depositing money in an IRA can ease your life after retirement while helping you save on taxes and providing access to different investment opportunities in your youth.

Figure out which kind of IRA is best suited to your current and future plans, and open an account to safeguard and grow your savings. The choice will depend on a multitude of factors, such as your income stream, marital status, and much more.

The post Understanding IRAs: The Complete Guide is part of a series on personal finances and financial literacy published at Wealth Meta. This entry was posted in Personal Finance
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