Individual retirement accounts (IRA) allow employees to create personal retirement accounts that receive the tax benefits of an employee sponsored 401k plan. IRAs can be created at many banks and investment companies with a variety of investment options unlike employer controlled 401ks. An employee can contribute up to a certain amount each year set by the Internal Revenue Service (IRS) that does not incur taxes until the person withdraws the money from the account. The limits are $6,000 for employees in 2022, and individuals aged 50 and over can contribute an extra $1,000 each year.
A person may not be able to deduct contributions to their IRA if they have an employer sponsored retirement plan such as a 401k. If the employee or their spouse has another employer retirement plan, they may not be able to deduct the contributions if they make a certain amount each year. To see the income limitations, refer to the IRS charts here.
A person may begin taking money from their IRA when they reach 59 ½ years of age or meet certain exceptions such as for disability. If a person withdraws money from their IRA before they meet these requirements, the person must pay a 10% penalty tax on top of the other taxes on withdrawals. Once someone reaches the age of 72, they must begin making a specific amount of withdrawals from their IRA unless they continue to work.
Roth IRAs operate differently than IRAs with contributions being taxed in the year contributed to the account, but when the person withdraws money from the IRA upon retirement, the withdrawals will not be taxed. Roth IRAs do not require individuals to begin withdrawing money after reaching age 72. Unlike IRAs and 401ks, individuals and couples who exceed certain yearly income requirements may not be able to contribute at all to a Roth IRA, beginning to phase out after $129,000 for individuals. To see the income charts for 2022, refer to the IRS chart here.
[Last updated in December of 2021 by the Wex Definitions Team]