All About IRAs

Today I want to share some information about the Individual Retirement Account, also known as an IRA (or in some areas an Ira, like the guitarist from Yo La Tengo). IRAs are one of the easiest and best ways for ordinary people to save for retirement, but what I’ve learned through lots of different conversations is that they are also kind of mysterious and misunderstood. So my goal for this post is to cover some of the biggest & most important topics related to IRAs so that you can make more well informed decisions when it comes to your own saving & investing.

Here’s what we’re going to cover:

• What is an IRA and why you need to think about what you own inside it;

• Who can contribute to IRAs;

• The two main types of IRAs and what the differences are between them;

• How much you can contribute and whether you can have multiple IRAs;

• How the IRS treats the two main types of IRAs, including deductibility of contributions and what happens when you take money out;

• I will briefly touch on a technique that high-earners can use to move money into Roth IRAs;

• And I’ll wrap up by mentioning two types of more advanced IRAs that self-employed people might consider.

What Is An IRA?

First, let’s just start with the name: Individual Retirement Account. The first thing you’ll notice is the word “individual”, which means that an IRA can only be owned by one person — not a couple, not a company, but an individual. Obviously the word “retirement” is in there, so we can gather that the purpose of this account is to save for retirement. But, of course, not everyone actually wants to retire. If you’re one of those people who wants to work forever, just think of “more and better options” whenever you hear the word “retirement”. And finally, there’s the word “account”. Specifically, it’s an account in which you can hold investments and, because the government wants to encourage people to save for old age, there are tax advantages associated with these types of accounts.

So the first point I want to make is that an IRA is not itself an investment; rather, it’s an account in which you can hold investments. If you’re new to investing, you might not understand this distinction. Adding money to an IRA is a good thing, but if you don’t use that money to invest, then it just sits there as cash and you basically have a complicated savings account. That is not ideal. So again, when you put money into an IRA, you should use that money to buy investments. What kinds of investments you own inside an IRA will depend on your age, current financial health, and risk tolerance.

In terms of what you should own inside your IRA, I’d first like to say that you should not consider anything I say in this blog investment advice. I’m sending this out to a mass audience, so nothing I say could possibly incorporate all of the relevant factors in your life. Now, that disclaimer aside, I will say that the further you are from being financially independent – meaning you don’t need to work to support yourself – the more you need your money to grow. And conversely, the closer you are to financial independence, the more you need to think about balancing growth with preservation. I hope that makes sense.

Generally speaking, investing in stocks tends to be very volatile in the short-term – meaning they go up and down a lot from day to day – but are very reliable for building wealth if you extend your timeline to 10-15+ years. So if you’re more than 10-15+ years from being able to live off your investments, a stock-heavy mix is probably a good match. And generally speaking, investing in bonds tends to be more stable in the short-term and generate a little income to boot, but not really growth-oriented over the long-term. So as you get closer to financial independence, you can think about shifting some of your stocks or stock funds into bonds or bond funds to balance out growth with stability.

A rule of thumb is that a typical retiree mix might be 50% stock funds and 50% bond funds, while 90% stocks and 10% bonds would be considered very aggressive, and therefore appropriate for someone with decades to go. My personal belief is that everybody’s investing superpower is being able to own the same investments for a really, really long time, because then you get to enjoy the benefits of compound growth. So I always try to match someone with an investment mix that fits not only their timeline & goals, but also how they feel about risk. I’d much rather you own investments that let you sleep at night – and therefore you can own them for a really long time – than try to optimize everything and put you in investments that are technically correct but stress you out. Ok? I think it’s better to buy things you can own for a long time, even if it means you’re not totally optimized for growth at all times. I hope that makes sense.

Who Can Contribute To IRAs?

In order to contribute to an IRA, the first requirement is that you have earned income. In other words, did you work for compensation? If so, then you can contribute to an IRA. If not, then you cannot contribute. And by the way, that also applies to minors: if a minor has earned income, then he or she can contribute to an IRA. Wild, right? If you have a kid at home with any reportable income, you can consider getting them on the saving & investing tip early by opening a minor IRA. There is one small asterisk when it comes to having earned income: spouses can contribute to each other’s accounts, so even if one spouse earns most or all of the household income, both spouses can contribute to IRAs.

The two main types of IRAs and the differences between them

There are two main types of IRAs and I’d like to give you a quick overview before diving into some of the details.

The two main types of IRAs are Traditional and Roth. Traditional is kind of an industry term, but most people might think of it as just the “regular” type where you get a tax break for contributing. The downside is that all distributions from Traditional IRAs are taxed as ordinary income, including the money that you originally put in. Roth IRAs, on the other hand, offer no current year tax break, but the upside is that all growth, dividends, and interest can be taken out tax-free in retirement.

So the big picture difference is when you pay taxes on your contributions. With Traditional IRAs, you can avoid paying taxes on that money now, but you’ll pay taxes on that money and all of the growth later. With Roth IRAs, you pay taxes on the money now but you won’t pay any taxes on the growth, dividends, or interest later. And, compounding being what it is, with enough time that growth could easily double or triple what you originally put in, so balancing the near-term and long-term tax consequences is important.

How much can you contribute to IRAs and can you have multiple IRAs? 

The amount that you can contribute is the lesser of the current annual maximum or total earned income, whichever is less. The annual maximum for 2026 is $7,500, so if you earn $8,000 this year, then you could put $7,500 into an IRA. However, if you only earn $6,000 this year, then $6,000 is the most you can put in. Does that make sense? You can only put in the maximum contribution if you made that much or more; otherwise the most you can put in is total earned income. FYI – the annual maximum changes from year to year, so just do a quick google search if you’re trying to figure out the most you can contribute.

Additionally, there is no rule that you can only have one IRA or even that you can only contribute to one IRA per year. The rule is that there is a maximum amount you can contribute to IRAs each year, but those contributions could be spread across multiple accounts. For example, you could have 10 different IRAs and put $750 into each of them, which would max out your contributions for the year. Now, I can’t see a lot of utility in doing that and don’t recommend it, but I just wanted to make the point that the rule is around the total amount you can contribute, not around the number of accounts. 

However, if you qualify to contribute to both a Traditional IRA and a Roth IRA, you could choose to split your contributions between them so that you get some immediate tax benefit with the Traditional account and some tax-free distributions in retirement from the Roth account. As long as your contributions don’t exceed the annual maximum, that’s totally allowed. And I see a lot of benefit in getting both kinds of tax advantages.

Or if you have an up & down income like most self-employed people, you could have a Traditional and a Roth and choose to contribute to the Traditional during the years where you make more money – and therefore the tax deduction would mean more – and contribute to a Roth IRA during the lower income years when you would see less benefit from a current year tax break. Does that make sense? If you make more money in a given year, you’ll see a bigger impact from a tax deduction so the Traditional IRA makes sense. If you make less money in a given year, then the tax deduction won’t mean as much and so you could choose to forego a current year tax break in favor of the tax-free distributions from a Roth IRA.

How the IRS treats the two main types of IRAs, including deductibility of contributions and what happens when you take money out

Now let’s talk about the tax advantages of IRAs. Remember that what makes an IRA different from a “regular” investment account is that the IRS has different tax rules for IRAs. Regardless of which type of tax-advantaged retirement account you use — whether an IRA, Roth IRA, or workplace 401(k) — there are no taxes owed on any dividends or interest or capital gains within the account as long as the money stays in there. So as long as you keep your money invested in the account, it can grow tax-deferred. That’s true of all IRS-approved retirement accounts.

But the IRS does not have infinite generosity. They want you to save for retirement, but they also want to get their tax money eventually. So let’s look at how the IRS treats the two main types of IRAs.

I already said that the IRS doesn’t give you any tax break for contributing to a Roth IRA, but they let you take all the money out tax-free in retirement. In other words, you owe taxes on the money you contribute now, but — as long as you follow the rules and wait until the right age — you’ll never owe taxes on that money again. You can think of contributions to Roth IRAs as “after tax”, meaning the IRS will get their cut during the year that you contribute. And, since they already got their slice and there are no taxes owed on the money you take out in retirement, the IRS doesn’t care if you ever take that money out. That means you could keep investments in your Roth IRA for a really, really long time to take advantage of compounding growth.

Not a bad deal, right? The only stipulation is that Roth IRA contributions can only be made if your income falls below certain thresholds. Those thresholds change from year to year and you can easily check the current year’s rules with a quick Google search, but the thing to remember is that Roth IRAs are designed to benefit lower-income earners. So if you earn too much money, you can’t contribute to a Roth IRA.

Traditional IRAs are different. Remember that contributions to Traditional IRAs can be deductible — meaning they can give you an immediate tax break — but the tradeoff is that all money that comes out in retirement is taxable at your ordinary income tax rate. These contributions are considered “pre-tax” since you don’t pay tax on the money when you put it in. But, because the IRS wants to get their taxes eventually, they actually require you to start taking money out once you reach a certain age. Those are called Required Minimum Distributions, or RMDs, and if you don’t plan ahead, you could end up having big tax consequences later in life.

Now, anyone with earned income can contribute to a Traditional IRA, regardless of income. However, the deductibility of those contributions depends on two factors: 1) whether you participate in a workplace retirement plan like a 401(k); and 2) how much money you make. If you do not participate in a workplace retirement plan, then contributions to a Traditional IRA are always fully deductible, regardless of your income. Ok? So if you don’t have any workplace retirement account, you can deduct any contributions to a Traditional IRA. However, if you do participate in a workplace plan, then the deductibility of your contributions depends on your income. If you participate in a workplace plan and make too much money, then your contributions are not deductible. Keep in mind that you can still contribute, but you won’t get any tax break. It’s important to note that participation in the workplace plan doesn’t just mean that you put money in. You’re also considered to have participated if your employer puts money in. So that’s definitely something to be aware of for high-earners who also have a workplace retirement account.

So a quick summary: 

IRAs are investment accounts that the IRS treats differently than regular investment accounts. All IRAs have tax-deferred growth, meaning you don’t owe any taxes on your investments as long as they are held in the account. Traditional IRAs can give you a current year tax break, but all the money is taxable when you take it out. Roth IRAs offer no current year tax break, but all the growth along the way is tax free when you take it out in retirement. The deductibility of Traditional IRA contributions depends on whether you have a workplace plan and how much you make, while the ability to make Roth IRA contributions only depends on how much you make, regardless of whether you have a workplace plan or not. And FYI, the Roth phaseout for 2026 starts at around $150k for single filers and around $240k for married filers, so most people will be allowed to contribute to a Roth IRA.

Now let’s talk about taking the money out. Retirement is a flexible concept, right? While most people think about retirement as something that happens in their 60s or even 70s, other people might want to retire young or never retire at all. And, of course, some people might decide that they actually can’t wait until retirement to access that money because they need it right away.

The official age when you can access money in an IRA is 59 ½. That’s a stupid rule, because who thinks about when they turn half a year older? If you turn 59 ½ in July but you take money out in June, you’ve broken the rule because you’re only 59 5/12. Totally stupid. They should just make it age 60 and then everyone would understand the rule right away. But, I’m not in charge of the tax rules, so 59 ½ is when you can access that money without any penalties. 

If you need to take money out before age 59 ½, though, you should be prepared for some unpleasant consequences. First of all, if you take money out of an IRA too early, then you’ll owe any applicable taxes on that money. Plus, depending on the type of account and how long you’ve owned it, you may also owe a mandatory 10% penalty on your withdrawals. So if you take money out of an IRA too soon, you might be looking at giving up 30% or more of that money right off the bat. I have to tell you, 30% is a steep price to pay to access your money, so I encourage everyone to only put money in a retirement account that you’re confident you won’t need for a long time. If you think you’ll need that money in the next few years, it’s best to keep it in an interest-bearing cash account in a bank.

And again, because the IRS wants their tax dollars from the money in your Traditional IRA, they require you to take it out starting at a certain age. For nearly everyone listening to this, your RMD age will be 75. But, for people born before 1960, the RMD age is earlier. This is important to keep in mind because investments tend to compound over time. For example, investments that grow an average of 10% per year – like the stock market – will tend to double about every 7-8 years. So if you have $1 million in an IRA at age 65, you could easily have twice that much at your RMD age of 75. That means that you could be forced to take out more money than you actually need, which will push you into a higher tax bracket for no reason. If you anticipate having a really large Traditional IRA or 401(k) balance when you retire, it’s worth your time & money to make a plan for how you’ll distribute that money in the most tax efficient way. P.S., that’s the kind of thing a Certified Financial Planner™ can help you do.

A technique that high-earners can use to move money into Roth IRAs

I’m going to take you on a brief aside. It’s a little in the weeds, so I’ll try to keep it quick and understandable. I just said that anyone with earned income can contribute to a Traditional IRA, but if you participate in a workplace plan and make too much money then it doesn’t get counted as deductible. This is considered an after-tax contribution, because you have to pay taxes on that money. It’s natural to ask: why would anyone want to do that? I mean, you don’t get a tax break now, plus you owe taxes on everything later. Seems like a bad deal, right? 

Well, remember that only people below certain income thresholds can contribute to a Roth IRA. And Roth IRAs have this great advantage that all distributions are tax-free in retirement. But it is possible to take money from a Traditional IRA and transfer it to a Roth IRA. This is called a Roth conversion. So a person can make a non-deductible, after-tax contribution, wait some amount of time, then move that money to a Roth account. This is a way for people who don’t qualify to contribute to Roth IRAs to move money into them. There’s a little bit more to it than that, but that’s the basic idea.

Now, let me be straight up and say that the topic of Roth conversions is too deep for what I want to discuss today, but I just want to mention that there is a reason why someone who can’t deduct contributions to a Traditional IRA might still want to make them. If you have a question about using this Roth conversion technique, please shoot me an email and we can dig a little deeper into how this works and why you might want to do it.

Ok, back to the main conversation: 

Two types of more advanced IRAs that self-employed people might consider

The last thing I want to mention today are two types of employer-sponsored IRAs that self-employed people can use to save more money than they can in a Traditional or Roth IRA. One is called a SEP IRA and the other is called a SIMPLE IRA. These are employer-sponsored accounts where you are both employer and employee. Keep in mind, though, that using either of these types of accounts means that you will be participating in a workplace plan, so that impacts the deductibility of Traditional IRA contributions.

A SEP IRA stands for Simplified Employee Pension Individual Retirement Account. It is a stupid name, because it’s not a pension at all. But that’s what the name means. SEP IRAs can only receive employer contributions and the maximum contribution is based on a percentage of your total year compensation. If you’re a sole proprietor, partner in a partnership, or member of an LLC, that means the maximum contribution is a percentage of your total year profits. The maximum you can contribute is 25% of compensation, but for technical reasons that involve how self-employment tax is calculated and paid, the actual max works out to 18.59%. If you want to get into the weeds on that math, send me an email. However, if you elect to be treated as an S-Corp, then the maximum SEP contribution is 25% of your salary and not 25% of the total year profit.

A SIMPLE IRA stands for Savings Incentive Match Plan for Employees Individual Retirement Account. It just rolls off the tongue, doesn't it? Unlike a SEP IRA, SIMPLE IRAs allow for both employee and employer contributions. The maximum employee contribution for 2026 is $17k and the employer maximum contribution is up to 3% of salary, so, depending on your situation, you might actually be able to contribute a little more with a SIMPLE than with a SEP. However, despite the name, SIMPLE IRAs are actually more complicated than SEPs, which is one reason why I don’t always like them.

In any case, as the names of these accounts imply, once the money is in them, it belongs to the individual. So even though they’re employer-sponsored accounts, the individual controls them. This is different from 401(k) plans where the employer hires a company to administer the plan and that company may limit what you can own in the account or how you can access the money.

I don’t want to go much deeper into SEP or SIMPLE IRAs, but I did want to mention them as an option for self-employed people. Depending on your income, you might be able to put aside a lot more money in one of these accounts compared to a Traditional or Roth IRA.

Ok, that was a ton of information and I hope you now have a better understanding of IRAs and how they work. As a reminder, the IRS wants to encourage you to save for retirement, so they give tax advantages to accounts called IRAs. All investments inside an IRA can grow tax-deferred as long as the money stays in the account. How the money gets treated when you take it out depends on 1) are you older than 59 ½ and 2) is it a Traditional account or a Roth account. If you take out the money too young, you can owe both penalties and taxes, so avoid that whenever possible. Assuming you wait until after age 59 ½, all distributions from Traditional accounts get taxed as ordinary income, and distributions from Roth accounts are tax-free. And since the IRS wants to get their tax money from your Traditional IRA, they make you start taking money out at a certain age. But, since they won’t get any taxes from your Roth account, they don’t care if you leave that money in there forever.

If you want to have a conversation about whether your investments line up with your best vision for the future, hit me up. This email address is always checked by yours truly.

Thanks,

Timothy Iseler, CFP®

Founder & Lead Advisor

Iseler Financial, LLC | Durham NC | (919) 666-7604

Iseler Financial helps creative professionals remove stress while taking control of their financial lives. We'll help identify current your strengths and weaknesses, clarify and refine your long-term goals, and prioritize decisions to improve your financial well-being now and later. Reach out today to take the first step.