What Is An IRA? Types, Rules, And Eligibility Explained

Choosing where to save for retirement can feel like a maze of options. An Individual Retirement Account, or IRA, is one of the most common ways to build long-term savings with potential tax benefits. From Traditional and Roth IRAs to SEP and SIMPLE plans, each has its own rules, contribution limits, and advantages. 

If you’re curious about how these accounts work, what sets them apart, and who can use them, read on.

What Is an IRA?

An IRA (Individual Retirement Account) is a tax-advantaged account designed to help you save for retirement. You can contribute if you have taxable compensation, also called earned income. These accounts can be especially helpful for people without access to an employer-sponsored 401k.

There are several types of IRAs:

Every IRA has its own tax treatment, contribution limits, withdrawal rules, and eligibility requirements. Depending on the type of plan, you may receive tax breaks up front or enjoy tax-free withdrawals later.

📝 Note: SEP and SIMPLE IRAs typically have higher contribution limits than Traditional or Roth IRAs, but they also come with extra eligibility rules and administrative requirements.

Types of IRAs

There are several types of IRAs, each with its own rules, contribution limits, and tax benefits. The most common are the Traditional and Roth IRAs. SEP and SIMPLE IRAs are designed for business owners and small employers.

IRA Comparison Table

Account	Contribution Limits (2025)	Roth Feature (SECURE 2.0)	✅ Pros	❌ Cons
SEP IRA	$70,000 (up to 25% of compensation; compensation cap $350,000)	Possible (if provider supports)	High contribution limits; simple to administer	Employer contributions only (no employee deferrals); Roth availability varies by provider
Roth IRA	$7,000; $8,000 if age 50+	Yes	Qualified withdrawals tax-free; contributions withdrawable anytime; no RMD for owner	Small contribution limit
Traditional IRA	$7,000; $8,000 if age 50+	No	Contributions may be tax-deductible (depends on MAGI and workplace plan coverage)	Small contribution limit; high-income earners may have limited deductibility if covered at work
SIMPLE IRA	$16,500; $20,000 if age 50+	Possible (if provider supports)	Simple, cost-effective plan; employer contributions; tax-deductible contributions	Roth availability depends on provider; lower limits than 401k; 25% early-withdrawal tax if within 2 years

Traditional IRA

A Traditional IRA is a tax-deferred retirement account funded with pre-tax or after-tax dollars, depending on your income and eligibility. Contributions may reduce your taxable income in the year you make them.

✅ Contributions: $7,000 for 2025; $8,000 if age 50+. May be deductible depending on MAGI and workplace plan coverage.

✅ Withdrawals: Qualified withdrawals allowed at 59½. Taxed as ordinary income.

✅ Early Withdrawals: Generally subject to income tax + 10% penalty unless an exception applies.

✅ RMDs: Required beginning at age 73. Refer to the RMD table to calculate your RMD amounts.

✅ Eligibility: Must have taxable compensation. Income does not bar contributions but may limit deductibility.

✅ Tax Deduction Limits (2025):

📝 Note: These MAGI limits apply if you — or your spouse — are covered by a workplace retirement plan. You can calculate MAGI using Worksheet 1-1 in IRS Publication 590-A.

Roth IRA

A Roth IRA works like a Traditional IRA but flips the tax treatment. Contributions are made with after-tax dollars. You don’t get an immediate deduction, but qualified withdrawals in retirement are tax-free.

✅ Contribution Limits (2025): $7,000; $8,000 if age 50+
✅ Withdrawals: Contributions can be withdrawn tax- and penalty-free anytime. Earnings can be withdrawn tax-free if you’re at least 59½ and your Roth IRA is at least five years old
✅ Early Withdrawals: Contributions are never penalized. Earnings withdrawn early may be taxable and may incur a 10% penalty unless an exception applies (such as disability, first-home purchase, or birth/adoption)
✅ Eligibility Rules: Anyone with earned income. Roth IRA contribution eligibility depends on 2025 MAGI limits.

📝 Note: If your income is too high for direct contributions, many people use a backdoor Roth IRA (non-deductible Traditional IRA to Roth conversion) or a mega backdoor Roth IRA workaround.

SEP IRA

A SEP IRA (Simplified Employee Pension) is designed for self-employed individuals and small business owners. It allows much higher contribution limits than Traditional or Roth IRAs. Contributions are made by the employer (including self-employed individuals).

✅ Contribution Limits (2025): Up to $70,000 (25% of compensation; compensation cap $350,000)
✅ Funding: Employer contributions only (no employee deferrals)
✅ Withdrawals: Qualified distributions allowed starting at age 59½; taxed as ordinary income
✅ Early Withdrawals: 10% penalty plus income tax unless an exception applies
✅ RMDs: Required beginning at age 73
✅ Eligibility Rules: Any business owner or self-employed individual with few or no employees.

📝 Note: Contributions must be made at the same percentage for all eligible employees. Roth SEP contributions are allowed under SECURE 2.0, but availability depends on the provider. If you’re self-employed with no employees, you may also qualify for a Solo 401k, which can offer even more flexibility than a SEP IRA.

SIMPLE IRA

A SIMPLE IRA (Savings Incentive Match Plan for Employees) is designed for businesses with 100 or fewer employees. It lets employees make elective deferrals, and employers must make contributions.

✅ Contribution Limits (2025): $16,500; $20,000 if age 50+
✅ Employer Contributions: Must either match up to 3% of an employee’s salary or make a 2% non-elective contribution (based on a $350,000 max salary in 2025)
✅ Withdrawals: Qualified distributions allowed starting at age 59½; taxed as ordinary income
✅ Early Withdrawals: 10% penalty plus income tax unless an exception applies. If you withdraw within the first two years, the additional tax is 25% instead of 10%
✅ RMDs: Required beginning at age 73
✅ Eligibility Rules: Any business owner or self-employed individual with fewer than 100 employees. You can also open a SIMPLE IRA with zero employees, but Solo 401k plans may be better if you’re self-employed with no staff.

📝 Note: Some providers now allow Roth SIMPLE deferrals under SECURE 2.0, but availability varies.

How Does an IRA Work?

An IRA is a long-term savings account built for retirement. Anyone with earned income can contribute to a Traditional IRA. Roth IRA contributions are available only if your modified adjusted gross income (MAGI) is within the 2025 limits.

Withdrawals before age 59½ usually trigger taxes and penalties, though Roth contributions (not earnings) can be taken out anytime. Certain exceptions, such as first-time home purchases or qualified education expenses, may also apply.

Tax-Advantaged Growth

Money in an IRA grows tax-deferred. You don’t pay taxes on interest, dividends, or profits when you sell investments inside the account. Instead, you either:

Traditional vs Roth IRA

Your choice between a Traditional IRA and Roth IRA often depends on the type of tax advantage you want:

Traditional IRA

Roth IRA

Opening an IRA

You can open either a Traditional or Roth IRA with most banks, brokerages, or robo-advisors. Even if you already have a 401k at work, you may still qualify for Roth IRA contributions if your MAGI is within the 2025 limits.

📝 Note: Knowing your current tax bracket and expected retirement income can help you decide which type of IRA may offer the most benefit over time.

IRA vs 401k

Both IRAs and 401ks are retirement savings accounts, but they work in different ways. A 401k is an employer-sponsored plan, while an IRA is an individual account you open on your own. If you don’t have access to a workplace 401k, you typically can’t contribute to one. Self-employed individuals, however, may set up a Solo 401k instead.

Who Can Contribute

Contribution Limits

Investment Options

Employer Match

📝 Note: Employer matching is optional. Not every company offers it, and the terms can vary by plan.

What Can You Invest in Through an IRA?

IRAs can hold a wide range of investments. The IRS only restricts a few types of assets, so what you’re able to buy usually depends on your provider’s offerings.

✅ Allowed Investments: Individual stocks, mutual funds, ETFs, bonds, and many other publicly traded securities.
✅ Restricted Investments: Collectibles (art, antiques, coins), life insurance policies, and any prohibited transactions with a disqualified person.
✅ Alternative Assets: Real estate, private equity, and certain digital assets may be allowed, but they typically require a self-directed IRA and strict compliance with prohibited-transaction rules.

Self-Directed IRAs

Any IRA can be self-directed, including Traditional, Roth, SEP, or SIMPLE IRAs. A self-directed IRA expands your investment choices beyond typical bank or brokerage menus but still needs a qualified custodian and full adherence to IRA rules.

✅ Broader Investment Scope: Lets you access alternative assets not offered by standard IRA providers.
✅ Custodian Requirement: A qualified custodian must hold the assets, even if you have more control.

📝 Note: Most major banks and brokerages don’t offer true self-directed IRAs. You’ll usually need a third-party provider that specializes in the assets you want to buy.

Custodian-Directed vs. Checkbook Control

There are two main ways to structure a self-directed IRA:

✅ Custodian-Directed: You instruct the custodian to execute each investment.
✅ Checkbook Control: Your IRA owns an LLC or trust, and the manager can write checks or place investments directly — still subject to all IRA rules.

📝 Note: Checkbook control gives more operational flexibility but does not remove compliance responsibilities. For some investors, a Solo 401k with direct account control can be a more efficient option for making investments directly.

How to Open an IRA

Step 1: Confirm Your Eligibility

For a Traditional or Roth IRA, you’ll need taxable compensation. Roth IRA contributions also depend on the 2025 MAGI limits, so review the income thresholds before moving forward. For a SEP IRA or SIMPLE IRA, you must be self-employed or own a business. SEP IRAs work for any number of employees but require equal percentage contributions for all. SIMPLE IRAs are limited to businesses with fewer than 100 employees.

Step 2: Choose the Right Account Type

Decide which type of IRA suits your needs. Traditional and Roth IRAs differ in tax treatment and income eligibility, while SEP and SIMPLE IRAs cater to business owners and have unique contribution and administrative rules.

Step 3: Pick a Financial Institution

Most banks, brokerages, robo-advisors, and credit unions offer IRAs. SEP and SIMPLE IRAs are also available through many institutions, but it’s smart to confirm they handle the type you want before applying.

Step 4: Complete the Application

Fill out the institution’s application by providing your personal details, employment information, and contribution choices. For employer plans like SIMPLE IRAs, you’ll also manage plan setup and employee notices.

Step 5: Fund Your IRA

Transfer or deposit your first contribution according to the limits and deadlines for your IRA type.

Step 6: Stay Compliant

SEP and SIMPLE IRAs generally don’t require annual Form 5500 filings. Custodians handle reporting on Forms 5498 and 1099-R. Employers must follow plan setup and notice rules for SIMPLE IRAs.

📝 Note: Check current MAGI limits for Roth IRAs each year, and confirm contribution deadlines to avoid penalties.

Wrapping It Up

Opening an IRA is generally straightforward once eligibility and account type are clear. Traditional and Roth IRAs work well for individuals, while SEP and SIMPLE IRAs are designed for business owners. The main steps include confirming eligibility, selecting the right account, choosing a provider, and funding the account according to IRS rules.

As a next step, review your income, contribution limits, and long-term goals to determine which IRA fits your situation. Comparing providers and understanding each plan’s rules can also help you make an informed decision before opening an account.

📌 Also read: Best Self-Directed IRAs of 2025

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The Carry Learning Center is operated by The Vibes Company Inc. (“Vibes”) and contains generalized educational content about personal finance topics. While Vibes provides educational content and technology services, all investment advisory services discussed on this website are provided exclusively through its wholly-owned subsidiary, Carry Advisors LLC (“Carry Advisors”), an SEC registered investment adviser. The information contained on the Carry Learning Center should not be construed as personalized investment advice and should not be considered as a solicitation to buy or sell any security or engage in a particular investment, accounting, tax or legal strategy. Vibes is not providing tax, legal, accounting, or investment advice. You should consult with qualified tax, legal, accounting, and investment professionals regarding your specific situation.

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