What Is an IRA & Why Should You Invest in One?

What is an IRA? Learn about account setup, eligibility rules, contribution limits, tax advantages, and distribution requirements.

Working-age people typically invest in employer-sponsored retirement plans, like a 401(k) or 403(b). However, an individual retirement account (IRA) is usually the best option for freelancers, self-employed workers, and non-working spouses. So, what is an IRA?

An IRA is a long-term retirement savings account that provides investors with tax benefits. We’ll explore IRAs, detailing how to open an IRA, contribution limits, tax advantages, and investment options. We’ll also share how Composer’s automated trading tools can help you create an AI retirement trading bot that makes investing for retirement easy.

How do IRAs work?

Depending on your account type, money invested in IRAs grows tax-free or tax-deferred. You can contribute up to the annual limit, which varies based on IRS regulations. In addition to IRA contribution limits, the IRS also controls distribution rules, taxes, and penalties.

Let’s take a closer look at how IRAs work:

Account setup

Anyone earning an income can open an IRA, including minors and non-working individuals whose spouse earns an income. You can open an IRA through a bank, online brokerage, or investment advisor company.

Contributions

IRA account owners may contribute money up to the annual limit set by the IRS. Contribution limits vary by account type and the individual’s age. In 2024, you can contribute up to $7,000 ($8,000 for individuals aged 50 and older) to a traditional or Roth IRA.

Investment choices

IRAs offer investors numerous investment options, including stocks, bonds, exchange-traded funds (ETFs), mutual funds, and options. Some accounts, like self-directed IRAs, allow alternative assets, such as real estate, commodities, and cryptocurrencies.

Tax advantages

Tax considerations vary for traditional and Roth IRAs, affecting your taxable income when you make contributions or withdraw.

Traditional IRAs: Allow tax-deductible contributions, meaning you can reduce contributions from your taxable income that year. Contributions and earnings grow tax-free, and you pay ordinary income taxes based on your tax bracket when you take a distribution in retirement. However, the IRS limits the amount you can deduct if you also contribute to an employer-sponsored retirement plan, phasing out deductions completely for higher-income earners.
Roth IRAs: Accept after-tax contributions, meaning you pay tax on the income during the year you report contributions. Contributions and earnings grow tax-free, and you can withdraw contributions anytime without paying taxes or penalties. Earnings become tax-free once you reach 59½ and have held your account for at least five years.

Rules and regulations

As retirement accounts, IRAs operate under rules governed by the IRS. Although you can access funds anytime, you may pay a 10% early withdrawal penalty if you withdraw funds before age 59½ (excluding contributions from Roth IRAs). If you use a traditional IRA, you must take an annual required minimum distribution (RMD) starting at age 73. Failure to withdraw your RMD in time may incur IRS penalties of up to 50% of the RMD amount.

Types of IRA

IRAs offer investors flexibility with how and where they invest their money. However, some IRAs require you to meet eligibility standards before opening an account. The primary IRA types include the following:

Traditional IRA

The traditional IRA is the most popular IRA type. It allows tax-deductible contributions, and earnings grow tax-deferred until you take a distribution in retirement. The IRS taxes distributions as ordinary income, which you can take without a penalty beginning at age 59½. Once you reach age 73, you must take an RMD from your account each year.

Roth IRA

Roth IRAs accept after-tax contributions, meaning you cannot deduct contributions from your reportable income. Like traditional IRAs, contributions and earnings grow tax-free, and you pay no taxes on qualified withdrawals in retirement. Although Roth IRAs do not have RMDs, the IRS does not allow you to contribute to one if you earn too much income.

Simplified employee pension (SEP) IRA

SEP IRAs enable self-employed individuals and small business owners to save for retirement. Employers who open an SEP IRA can make tax-deductible contributions for their employees, including themselves.

In 2024, employers can contribute up to 25% of an employee’s income or $69,000, whichever is less. To contribute to an SEP IRA, you must be at least 21 years old, have worked for the same employer in three of the last five years, and have earned at least $750 during the current year.

Savings incentive match plan for employees (SIMPLE) IRA

SIMPLE IRAs are designed for small businesses with fewer than 100 employees. Unlike SEP IRAs, SIMPLE IRAs allow tax-deductible contributions from employers and employees, with employers able to choose between a 2% non-elective contribution based on the employee’s salary or matching employee contributions dollar-for-dollar up to 3% of the employee’s salary.

In 2024, total contributions may not exceed $16,000 ($19,500 for individuals age 50 and older). To contribute to a SIMPLE IRA, employees must have earned $5,000 or more in any two previous calendar years and at least $5,000 in the current year.

Self-directed IRA (SDIRA)

An SDIRA allows you to hold alternative investments normally prohibited by other IRAs, including real estate, cryptocurrencies, and commodities (e.g., precious metals). Depending on your preference and availability, SDIRAs come in traditional or Roth versions.

Inherited IRA

When an IRA owner dies, qualifying beneficiaries may transfer any remaining assets to an inherited IRA. Inherited IRAs operate under specific RMD and distribution rules depending on the beneficiary’s relationship to the deceased account owner.

Spousal IRA

A spousal IRA lets someone who doesn’t earn income contribute to an IRA using their spouse’s income.

Rollover IRA

A rollover IRA allows you to transfer assets from one retirement account type into another without incurring taxes or penalties. For example, you may roll funds from a 401(k) or SEP IRA into a rollover IRA. Doing so alters the regulations governing the account.

Why invest in an IRA?

IRAs offer investors numerous benefits that empower their retirement savings. Primary benefits include the following:

Tax advantages

Traditional IRA contributions may qualify as tax-deductible, resulting in tax savings that year. Roth IRA contributions and earnings grow tax-free, and you pay no taxes on qualified distributions, saving you money in retirement when you typically earn less income.

Long-term savings

IRAs offer tax-deferred growth, meaning you can significantly increase your savings over time. With time and consistent contributions, IRAs can grow into considerable investments.

Financial security in retirement

IRAs provide a structure for retirement investing, so you can reach your financial goals. You’ll be less likely to outlive your retirement savings, meaning you can enjoy your golden years with peace of mind. With a well-funded IRA, you can supplement other retirement income sources like Social Security, stretching out your savings.

Control over investments

IRAs offer numerous investment options, granting you control over your retirement savings. This flexibility lets you align investments with your risk tolerance and financial goals.

Today, platforms like Titan Invest and Composer simplify retirement savings by helping you make informed decisions with your money. By tailoring solutions to your circumstances, you can ensure your retirement plan stays on track.

Unlock the possibilities of automated trading with Composer

Composer is a revolutionary platform that lets you leverage AI algorithms in your investing strategy. Its no-code editor makes automated trading easy, so you don’t get bogged down in coding complexities.

With Composer, you can benefit from IRA tax advantages and the power of AI in a single account. Refine your investing strategy using Composer’s user-friendly interface, and discover new approaches developed by other users. Composer’s offers the best of both worlds, allowing you to invest for retirement and explore cutting-edge trading technology.