What are the different types of IRAs—and which one fits you?

Comparing the uses and advantages of various types of IRAs

While all these accounts can be useful in pursuing retirement goals, they’re not all interchangeable. All combine a potential tax advantage with investment choices. But selecting the right IRA for you will depend on personal factors—such as whether you seek tax-deferred or tax-free growth, if you’re trying to simplify your retirement savings, or you own a small business and want to get yourself and your employees started with retirement benefits. Here’s a rundown of the types of IRAs and what they’re typically used for.

1 Traditional IRA—to reduce your current income taxes and delay taxes on potential growth

A traditional IRA may let you deduct your contributions from your current year’s income taxes, if you meet the criteria for eligibility. Generally, whether they’re tax deductible depends on your income and if you have access to a workplace retirement plan. 

Any money in your traditional IRA has the potential to grow tax deferred until you withdraw it, so it may be a good choice if you expect your income-tax rate to be lower in retirement than it is today. But beware of early withdrawals—there, is generally a 10% penalty tax if you withdraw your money before you turn age 59½ unless an exception applies.

2 Roth IRA—the chance for your savings to grow, tax free

You may be able to contribute to a Roth IRA based on your modified adjusted gross income and tax filing status. With a Roth IRA, you invest after-tax money (that is, money you’ve already paid income taxes on). But as long as you follow the rules, you get to avoid future taxes on both: 

• Any withdrawals from your account, taken anytime, up to the total amount you’ve contributed

• The total interest, dividends, and market growth you earn on your money

What does it mean to follow the rules? Generally speaking, to qualify for fully tax and tax-penalty-free withdrawals from a Roth IRA:

You need to be age 59½ or older, or a distribution is made after death or disability, and

• At least five years must have passed since you first contributed to your account (the five-year rule)
• There are more specifics to consider when thinking about contributing to a Roth IRA. You may want to contact your plan consultant or financial or tax professional for specific details on your eligibility to contribute to a Roth IRA and Roth IRA distribution and taxation rules.

The “pay taxes today, pay no taxes tomorrow” nature of a Roth IRA can make it a valuable tool if you’re expecting your tax rate to climb in retirement. It can also make sense if you feel your long-term investment growth could be far larger than today’s tax bill. 

3 Rollover IRA—a way to simplify your retirement savings when you leave jobs or retire

A rollover IRA is an IRA (a traditional IRA or Roth IRA) that accepts funds from a retirement account, such as a 401(k) plan. 

• Traditional 401(k) accounts can be rolled over to a traditional IRA or Roth IRA. If rolled over to a Roth IRA, the amount of the rollover is taxable to the individual. 

• Roth 401(k) accounts can only be rolled over to a Roth IRA.

Some of the benefits of a rollover to an IRA include the potential ability to: delay immediate taxation (unless rolling over a traditional 401(k) account to a Roth IRA), avoid potential penalties, continue tax-deferred growth opportunities, and choose from a broader array of investment options. Once you open and fund your rollover IRA, you get all the benefits and services of any other traditional or Roth account. And, in case you’re wondering, you can roll balances from old workplace accounts into an IRA you’ve already opened, even if it isn’t called a rollover account.

If you change jobs or retire, you may consider combining multiple accounts into a single account, which may help to make retirement planning easier. It could also possibly help you save on account fees, as well as take greater advantage of an investment lineup or a provider you’ve grown to like.¹  

4 Nondeductible IRA—a way to make Roth investments beyond IRS limits

With a nondeductible IRA, you contribute after-tax dollars (like with a Roth IRA), but you also pay taxes on your account’s growth when you take withdrawals (as with a traditional IRA). Why would you want an account like this?

Even without the chance to make pretax or tax-deductible contributions, there can be a financial advantage to getting tax-deferred growth, especially if you expect to be in a lower tax bracket in retirement. 

But there’s also another potential benefit to a nondeductible IRA. IRS rules let you move the money in your nondeductible account to a Roth IRA through something called a backdoor Roth conversion. 

Depending on your situation, this maneuver might create new opportunities for tax-free growth. This is because backdoor conversions are allowable even if you’ve maxed out your Roth workplace plan and Roth IRA contribution limits, or you simply earn too much to contribute to a Roth IRA. 

Roth conversion rules are complex, and you may want to seek professional guidance. That said, it should come as no surprise that high earners and heavy retirement savers are fans of nondeductible IRAs and backdoor Roth conversions. 

5 SIMPLE or SEP IRA—a small business retirement solution 

If you’re self-employed or run a small business with a limited number of employees, a simplified employee pension SIMPLE IRA or SEP (simplified employee pension) IRA could be a good starter retirement benefit for you.²

Both the SIMPLE IRA and SEP IRA allow owners to set up accounts for themselves and their employees, but the key difference lies in how accounts are funded: 

• With a SIMPLE IRA, eligible employees can make contributions and business owners are required to make contributions for eligible employees

• With a SEP IRA, only the owners can make contributions for their eligible employees and themselves

Keep in mind that if you’re a growing business, a SIMPLE IRA or SEP IRA may just be a temporary step. For instance, there are attractive small business 401(k) plans available, many designed to grow right along with your company.

Can you have an IRA and a workplace retirement plan?

Yes. If you invest in a 401(k), 403(b), or other workplace plan, there could very well be a place in your retirement savings strategy for an IRA. For example, you might be able to make extra contributions to a traditional IRA or Roth IRA account, depending on your earnings. It’s also possible to move your old retirement savings into an IRA when you change jobs. This can make retirement planning easier for you.

With a workplace plan, you may be offered employer contributions, the power of saving through paycheck deductions, and other advantages, so it may be a good idea to prioritize your workplace retirement plan (if you have one available). If you do, an IRA may be a good way to supplement your savings strategy.

Before you decide on an IRA, know the facts

Opening an IRA can be an important part of your retirement savings strategy. And the type of IRA you choose depends on a range of factors, including your retirement goals, your current and expected future tax situation, and the availability of a workplace plan. 

What type of IRA might be right for you and when’s the best time to act? To help answer these questions, learn more about each type of account and what it’s designed to do. And don’t hesitate to talk to the people who make these decisions all the time—a financial or tax professional.