Ask a CFP® – Foundational Questions Edition: What’s an IRA?

Welcome back to our Account Types Series, part of the Ask a CFP® – Foundational Questions Edition, where we’re breaking down the most common types of investment accounts and how you might use each one in your retirement planning strategy.

Last week, we explored 401(k) plans — if you missed that post, you can read it here. This week, we’re turning to another widely used retirement account: the IRA. Short for Individual Retirement Arrangement (but more commonly known as an Individual Retirement Account), the IRA is often mentioned in the same breath as a 401(k). But how does it work, and what makes it different?

What is an IRA?

Just like a 401(k), an IRA is essentially a container that you place funds into. Inside that container, you can invest your money in a variety of ways (e.g., stocks, bonds, mutual funds, and more) with the goal of growing it over time to fund your future retirement needs.

The main difference? A 401(k) is tied to your employer, while an IRA is something you open and manage on your own, independent of your workplace. This flexibility brings its own set of rules, contribution limits, and tax treatment, which we’ll break down below.

How do contributions to an IRA work?

With a 401(k), contributions are generally deducted straight from your paycheck. Since an IRA isn’t tied to your employer (note: we’re talking here about Traditional and Roth IRAs, not SIMPLE or SEP IRAs), you’re responsible for initiating contributions from your own bank account.

Here’s how the process works:

Step #1 – Are you eligible?
The good news is that for most people, qualifying is straightforward:

• You need earned income — wages, salary, or self-employment income — at least equal to the amount you contribute.

• You need a valid U.S. taxpayer identification number (such as a Social Security Number or Individual Taxpayer Identification Number).

• For Roth IRAs, additional income limits apply. (You can view the IRS guidelines here).

Step #2 – Choose a custodian and open your account
Common examples include but are not limited to Schwab, Fidelity, and Vanguard. Once you choose, open either a Traditional or Roth IRA depending on your eligibility and tax strategy. (We’ll compare the two in next week’s post.)

Step #3 – Choose a contribution amount and frequency
In 2025, the contribution limits are:

• Under age 50 = $7,000

• Ages 50 and older = $8,000

You (or your spouse) must have earned income for the year equal to or greater than your contribution amount. Examples:

• A 20-year-old earning $5,000 could contribute up to $5,000 (not the full $7,000).

• A stay-at-home parent with $0 earned income can contribute the full amount if their spouse earns enough to cover it.

• A partially retired couple over age 50 with $14,000 total earned income could split that between their IRAs in any combination, as long as neither exceeds $8,000.

Once you’ve chosen an amount, we tend to find that automation is key. So pick a frequency (many choose bi-weekly to match their paycheck frequency or monthly to match other cash outflows) and then set up an automatic transfer from your checking account to your new IRA. Treat is just like your rent/mortgage or subscription of choice and work it into your budget on a regular automated basis, so you don’t have to think about it.

You can also make a lump-sum contribution if you have available cash (e.g., from a bonus or savings).

Timing tip: IRA contributions can be made up until the tax-filing deadline for the prior year (usually mid-April).

Step #4 – Don’t forget to invest the funds!
Now that you’ve got funds into the IRA, comes maybe the most important (and too often forgotten) step: invest your money! Remember, an IRA is not an investment. It’s just the container that can hold investments if you invest the funds once they’re in there. Once contributions are in, you’ll need to choose investments aligned with your goals, time horizon, and risk tolerance. Options often include mutual funds, ETFs, stocks, and bonds – more on that below.

Are there tax advantages to using an IRA?

Yes! Both Traditional and Roth IRAs offer potential tax benefits, but they work in very different ways.

Traditional IRA

• Potential Tax Deduction: Depending on your income and whether you (or your spouse) have a retirement plan at work, your contribution to a Traditional IRA may be deductible from your taxable income (there are multiple thresholds depending on your situation). This deduction can ultimately help you save on taxes in the year you make your contribution.
  Example: You earn $65,000 in 2025 and contribute $7,000 (the maximum for someone under age 50). That $7,000 could be deducted from your taxable income, potentially lowering your tax bill by around $1,000. (Note: This depends on your full tax picture. Consult with your tax advisor to determine your eligibility.)

• Tax-Deferred Growth: As long as your funds remain within the IRA, any dividends, interest, or gains from selling investments inside the IRA are not taxed at that time. Eventually, the funds you take out will count as taxable income, but ideally, that won’t happen until many years down the road.

The fact that taxes aren’t owed every year can be a powerful force — allowing your earnings to compound year after year, without being interrupted by the need to pay taxes. It also lets you rebalance your portfolio without worrying about triggering capital gains taxes (which we’ll discuss in our upcoming post on taxable brokerage accounts).

Roth IRA

Roth IRAs take a different approach. You don’t get a tax deduction when you contribute, but the primary benefit is tax-free growth and tax-free withdrawals in retirement.

If certain requirements are met (generally, the account must be open for at least five years and you must be age 59½ or older) both your contributions and the earnings on those contributions can be withdrawn without owing any taxes.

This can provide valuable flexibility when building a retirement income plan — especially for managing your taxable income in retirement. And, just like a Traditional IRA, you can rebalance without triggering capital gains taxes.

What can I invest my IRA funds in?

One of the biggest advantages of an IRA compared to a 401(k) is the wide range of investment choices. In most cases, you can invest IRA funds in:

• ETFs and mutual funds

• Individual stocks and bonds

• Money market funds

• A variety of asset types and markets, including:

  • U.S. and international companies

  • Government securities

  • Precious metals

  • Real estate

  • Even certain cryptocurrencies

This flexibility means you’re not limited to the pre-selected menu of options that most 401(k) plans provide.

If you prefer a “set it and forget it” approach, IRAs often offer target-date funds—diversified portfolios that automatically adjust their mix of investments as you approach a chosen “target date” for retirement. These can be a simple, hands-off way to keep your investments aligned with your timeline.

Why use an IRA (even if you already have a 401(k))?

An IRA, or Roth IRA, can be a great complement to your 401(k), offering benefits that go beyond what most workplace plans provide:

• Broader Investment Choices – Most IRAs give you access to a far wider range of investment options than the pre-selected menu in a typical 401(k) plan. This flexibility can help you diversify your portfolio in ways that might not be possible inside your employer plan.

• Additional Tax-Advantaged Savings – If you’re already contributing the maximum to your 401(k), an IRA can give you another way to save for retirement—either with tax-deferred growth in a Traditional IRA or potential tax-free withdrawals in a Roth IRA.

These features make IRAs a valuable tool for building a more flexible and personalized retirement strategy.

When can I withdraw funds from my IRA?

In general, IRAs and Roth IRAs are designed for long-term savings, and withdrawals before age 59½ can trigger a 10% early withdrawal penalty in addition to any taxes owed. But there are exceptions worth knowing. The IRS provides a helpful guide, but here are a few of the most common exceptions that may help you avoid the 10% early withdrawal penalty:

• Death of the account owner

• Disability of the account owner

• Birth or adoption expenses (up to $5,000 per child)

• Qualified first-time homebuyers (up to $10,000)

• Qualified higher education expenses

Tax treatment still matters
Pre-tax funds from a Traditional IRA will still count as taxable income when withdrawn — the exceptions above only waive the 10% penalty.

For Roth IRAs, contributions (what you put in) can be withdrawn at any time tax- and penalty-free. Earnings (the growth) can only be withdrawn tax- and penalty-free once you’ve had a Roth IRA open and funded for 5 years and you’re age 59½ or older, or meet another qualifying reason (like death, disability, or first-time home purchase).

Knowing these rules can help you plan withdrawals strategically—avoiding unnecessary penalties and potentially reducing your tax burden.

What happens to my IRA if I change jobs?

In most cases, nothing at all. Traditional and Roth IRAs are independent of your employer, so switching jobs doesn’t require any action with your IRA. However, a job change can indirectly affect your IRA in a few ways:

• Income Changes – If your earned income changes significantly, it could affect how much you can contribute—or whether you’re eligible to contribute to a Roth IRA or deduct Traditional IRA contributions.

• 401(k) Rollovers – When you leave a job, you may choose to roll over your old 401(k) or other workplace retirement plan into an IRA. This can be a great way to consolidate accounts and expand your investment choices. Just remember, a rollover isn’t your only option — our What’s a 401(k)? post walks through the alternatives.

The key takeaway: changing jobs won’t disrupt your IRA, but it’s a good opportunity to review your retirement accounts and make sure everything is still aligned with your goals.

Am I ever forced to withdraw funds from my IRA?

Yes, but only for Traditional IRAs. Eventually, the IRS wants to collect taxes on your retirement savings. If you haven’t emptied your Traditional IRA by a certain age, you’re required to begin taking minimum annual withdrawals known as Required Minimum Distributions (RMDs).

• If you were born between 1951 and 1959, RMDs begin at age 73.

• If you were born in 1960 or later, they begin at age 75.

The amount you must withdraw each year is based on:

• Your age

• Your IRA balance at the end of the previous year

And yes, these distributions are taxable. While paying taxes isn’t fun, there are ways to manage and potentially reduce the tax impact over time, such as:

• Roth conversions

• Qualified Charitable Distributions (QCDs)

• Tax-bracket management

It’s rare to spend all of the funds in your Traditional IRA by the time you reach your required RMD age, so RMDs eventually apply to most IRA owners — but that’s not necessarily a bad thing (it’s still your money to spend…it’s just time to pay the taxes).

For Roth IRAs, there are no lifetime RMDs for the original account owner. However, beneficiaries who inherit a Roth IRA generally must withdraw all funds within 10 years.

Who gets my IRA if I pass away?

When you pass away, your IRA or Roth IRA goes to the beneficiary (or beneficiaries) you’ve named on the account—avoiding the probate process in most cases. A spouse beneficiary can choose to take the account as their own, while other beneficiaries typically open an “Inherited IRA.”

Beneficiary rules can be complex, but one simple takeaway is this: make sure you’ve named beneficiaries and review them periodically to ensure they still align with your wishes.

TL;DR – IRA Quick Guide

What it is:
An IRA (Individual Retirement Account) is a personal retirement account you open yourself—not through an employer—designed to grow your savings with tax advantages.

Key Types:

• Traditional IRA – May give you a tax deduction now, grows tax-deferred, withdrawals taxed in retirement, RMDs apply.

• Roth IRA – No deduction now, grows tax-free, qualified withdrawals tax-free, no lifetime RMDs for the original owner.

2025 Contribution Limits:

• Under age 50: $7,000

• Age 50+: $8,000

• Must have earned income at least equal to contribution.

Why use one:

• Broader investment options than most 401(k) plans

• Additional tax-advantaged savings space

Withdrawals:

• Generally penalty-free after age 59½ or due to an exception

• Some of the exceptions include disability, first-time home purchase, certain education expenses

• Roth IRA contributions can be withdrawn anytime tax- and penalty-free

RMDs:

• Traditional IRA: Begin at age 73 (born 1951–1959) or 75 (born 1960+).

• Roth IRA: No lifetime RMDs for original owner; inherited Roth IRAs must be emptied within 10 years.

Looking Ahead

We’ll continue the Account Types Series next week with:

What’s the difference between a Traditional IRA and a Roth IRA?

If you have a question you’ve always wanted to ask, basic or otherwise, send it to us at ask@sandersretirement.com. We’d love to include it in an upcoming post.

All content is for informational and educational purposes only and should not be construed as personalized investment, tax, or legal advice. Sanders Retirement Planning LLC does not provide legal or tax advice. Please consult your financial advisor, tax professional, or attorney regarding your specific situation. The information provided is believed to be from reliable sources, but its accuracy and completeness cannot be guaranteed. Links to third-party sites are for informational use only and do not constitute an endorsement. Past performance is not indicative of future results. All investments carry risk, including the potential loss of principal. Advisory services offered through Sanders Retirement Planning LLC, a Registered Investment Adviser. Services may not be available in all jurisdictions.