When you think about retirement savings, most people have two distinct buckets: employer sponsored retirement plans and individual retirement plans. Employer sponsored plans revolve around employers providing additional pay in the form of retirement contributions. Individual retirement plans involve someone putting away their own money independently into an account that gets special tax benefits.
What is an IRA?
IRA stands for “individual retirement account.” These investment accounts let individuals set aside money for retirement by giving preferred tax treatment. There is no employee component to an IRA.
Importantly, an IRA is not an investment itself – it is just an investment vehicle. In other words, it is a type of account that you put money in and then decide how to invest it. You can still invest in stocks, bonds, ETFs, or anything else that you can invest in through a traditional brokerage account.
There are two main types of IRAs: traditional and Roth. We’ll get into the difference between them in a different article. Regardless of the type, an IRA has a contribution limit so you can only submit a certain amount of money each year. In 2022, the contribution limit is $6,000.
Contributions to IRAs must be from earned income. In other words, you cannot take $6,000 from previous savings or from a family member and contribute that money to an IRA. You have to be able to point to specific income that you contributed to your IRA and you cannot contribute more than you earned in a specific year.
Both types of IRAs can be opened by individuals through large financial institutions, including Fidelity, Charles Schwab, and Vanguard. You can open one of these accounts on your own with no involvement from an employer.
If an IRA is basically the same thing as a brokerage account, what makes it different? The key distinction is how money earned in an IRA is earned. An IRA is meant to be a retirement savings account, so the tax code changes how investments are taxed if they are held in an IRA. Exactly how the taxes change depend on whether the IRA is “traditional” or “Roth.”
