There are two main types that benefit most savers: traditional IRAs and Roth IRAs. Both accounts let retirement savers stash away $6,000 ($7,000 for those 50 and older) for retirement annually and invest in a variety of funds, and both are tax-advantaged in their own ways. (There are a few other, less commonly used types of IRAs for certain types of workers.)

The key difference between the two is when investors pay taxes. With a traditional IRA, you contribute money pre-tax, meaning you lower your taxable income for the year in which you invest in it, similar to how a 401(k) works. You’re essentially deferring your tax payments.

With a Roth IRA, however, you invest money you’ve already been taxed on. After that, you don’t have to worry about paying taxes on your investments again — including gains — when you take distributions, unless you withdraw money early.

Investing in a Roth vehicle can save you significantly on taxes “when your savings horizon is long, allowing for more time for compounding earnings to grow your account balance, or [if] you believe you are in a lower tax bracket today than you will be when taking distributions in the future,” says Amy Ouellette, vice president of product at Vestwell, a 401(k) platform.

Roths are beloved by financial professionals because of the decades of tax-free growth they can enable. And for young workers and others in lower income tax brackets, they’re an especially good deal.

The benefits of a Roth IRA

When you contribute to a Roth IRA, you’re essentially pre-paying your taxes at your current tax rate, which could be lower than your tax bracket will be when you reach retirement, after decades of working and, presumably, growing your income.

Another under-appreciated benefit of Roths: Because you’ve already paid taxes on your contributions, you can take the cash out at any time, without paying a penalty. This only applies to your contributions, not any gains you earn on those investments. 

Let’s say you’re contributing $100 a month to your Roth IRA, and half-way through the year, you’re hit with a surprise bill you can’t afford. You can take out $600 from your Roth as a sort of back-up emergency fund without penalty, whereas if you took a distribution from a 401(k) or traditional IRA, you’d owe a 10% penalty and taxes. While you would miss out on the potential investment growth of that $600 moving forward, you’d avoid paying a premium for an unexpected expense. Of course, you also don’t want to treat your Roth as a savings account.

“I would consider the Roth to be a source of funds only for an emergency or major financial need, such as a job loss, medical emergency, or perhaps to round out a downpayment on a home purchase,” says Jane Voorhees, a certified financial planner and ALINE Wealth’s director of financial planning. “In most situations, you should just let it ride and grow tax free until retirement.”

IRA income limits

Roths do have income limits: Single tax filers can contribute to the account if their modified adjusted gross income is under $144,000 this year; the limit rises to $214,000 for married couples. Of course, there are ways around those limits for the wealthy.

There are no income limits to contribute to a traditional IRA. However, there are income limits for those contributions to be tax deductible for certain workers who have a work-sponsored retirement account.

How to open an IRA

Whether you opt for a traditional or a Roth, an IRA can be opened at most banks and credit unions; through online brokers and investment companies like Fidelity, Schwab, TD Ameritrade, Vanguard, etc.; or through a robo-advisor like Betterment, Ellevest, or Wealthfront.

Simply head to the provider’s website, and you can open an account in a few minutes using your name, Social Security Number, and a few other personal details. Then, determine how you want to fund it. You could add a lump sum, or make recurring contributions each month. Just remember, the limit for the year is $6,000 or $7,000, depending on your age. 

While the $6,000 to $7,000 limit applies annually, savers have more than 12 months to reach it: You can technically contribute to your IRA until taxes are due for the year. So this year, for example, you have from January 2022 to April 2023 (assuming the deadline doesn’t change) to max out your account, so long as you designate them as 2022 contributions.

Make sure to actually invest the money you are contributing. An IRA is simply a type of financial account that holds investments, like index funds. You need to select investments, and then buy them with your contributions. Many people opt for target-date funds in retirement accounts, which are already diversified and will be rebalanced to be less risky the closer you get to retirement.

Otherwise, your contributions will just sit there in cash. That’s not the worst thing in the world, but then your account is basically acting as a savings account and you won’t see the huge growth that you can get if it’s invested in the market. Of course, there’s no guarantee that your money will grow year over year when it’s invested, though, historically, it’s a pretty good bet.

And as with every financial product, consider the fees that companies change for these accounts. Most of the best accounts don’t levy a management fee (though you will pay a fee on your investments). Some will charge you between 0.25 to 0.3%, so make sure not to pay more than that, so you can make sure you’re getting the most out of your retirement investments and not missing out on growth because you’re bogged down by fees.

The earlier in your career you start investing, the better, thanks to the nature of compounding interest. But even if you’ve been working for a few years, it’s never too late to start.