What is an IRA and how does it work?
An IRA is a retirement account you open yourself. Anyone with pay from work can use one, and you pick its investments.
New to this?
An IRA is a retirement savings account you open yourself, online, at a company that holds investments for you. It is not tied to a job. Anyone who earns pay from work can have one. You move money in, choose what to invest it in, and get a tax break for saving for later.
Read first
Myth
My job has no 401(k), so I can't really save for retirement.
Truth
Anyone with pay from work can open an IRA and put in up to $7,500 in 2026. Leo's $250 a month could grow to about $304,993 in 30 years at an assumed 7%.
Worth memorizing
- 1
You open an IRA yourself.
It lives at a brokerage you choose, not at your job. It stays with you for life, through every job change.
- 2
The account does not invest itself.
Money you move in can sit as cash. Leo's $90,000 of deposits could grow to about $304,993 invested, at an assumed 7%.
- 3
The yearly limit is lower than a 401(k).
You can put in up to $7,500 in 2026, across all your IRAs, or your pay from work if that is less.
Here's what I'd do: open the IRA first, even before you pick the perfect fund, and set up an automatic monthly transfer. Then choose a low-cost broad index fund or target-date fund. The account sitting empty is the most common way this goes wrong.
Do this today
Decide whether you need an IRA: if your job has no 401(k), or you already get your full match, open one at a low-cost online brokerage. Set a monthly transfer, even $50, and choose one broad fund for it to buy.
Practice
1 of 3
Which of these is true about an IRA?
An IRA is your own account. You can have one along with a 401(k), and you choose the investments inside it.
2 of 3
You put $200 a month into an IRA. How much is that in a year?
$200 × 12 = $2,400 a year.
3 of 3
You moved $1,000 into a new IRA last month and did nothing else. What is most likely true?
Many IRAs hold new money as cash until you choose a fund. Moving money in and investing it are two separate steps.
Tips
Get any 401(k) match first
If your job matches 401(k) contributions, put in enough to get all of it. Then an IRA is a good next place for more savings.
Buy a fund after each deposit
Set up automatic investing, or log in after each transfer and buy your fund. Check that your cash balance is near zero.
Automate a monthly transfer
Link your checking account and schedule a fixed amount for the day after payday. Small amounts add up, and you don't have to remember.
Use the extra months
You can usually add money for a given year until the tax filing deadline the next April. Say which year a deposit is for.
A worked example: $250 a month in an IRA
Leo, 27, works for a small company with no 401(k). He opens a Roth IRA and sets up $250 a month. He compares investing it with leaving it as cash.
- Leo puts in $250 × 12 = $3,000 a year, well under the $7,500 yearly limit.
- Over 30 years his deposits add up to $3,000 × 30 = $90,000.
- In a broad index fund at an assumed 7% a year, growth adds about $214,993, for $304,993. Returns vary and can be negative.
- If he never picks a fund and the cash earns nothing, he has just the $90,000 he put in.
- Monthly transfer$250
- Put in a year$3,000
- Put in over 30 years$90,000
- Growth at an assumed 7%+$214,993
- Invested after 30 years=$304,993
- Left as cash earning 0%$90,000
Try your numbers
Reference
Leo's $250 a month in an IRA, assuming 7% a year before inflation. Returns vary and can be negative.
| Year | You put in | Growth | Balance |
|---|---|---|---|
| 1 | $3,000 | $98 | $3,098 |
| 10 | $30,000 | $13,271 | $43,271 |
| 20 | $60,000 | $70,232 | $130,232 |
| 30 | $90,000 | $214,993 | $304,993 |
Common mistakes
Leaving the money as cash
Money moved into an IRA often sits uninvested until you buy a fund. Log in, check your holdings and make sure the balance is in the fund you chose.
Putting in more than you earned
Your contribution can't be more than your pay from work for the year, or the yearly limit. Extra amounts face a 6% tax each year until you fix them.
Skipping the 401(k) match for an IRA
An IRA has more fund choices, but it has no match. If your job matches, get every matched dollar first.
Going deeper
An IRA, or individual retirement account, is a retirement account you open yourself at a brokerage, with no employer involved. Anyone with pay from work can put in up to a yearly limit, and you choose the investments that go inside it.
You open it, not your employer
An IRA is an account in your own name at a brokerage, which is a company that holds investments for you. It takes about 15 minutes online, and it moves with you from job to job.
You need pay from work
You can contribute if you earn wages, salary, tips or self-employment income. A spouse with little or no pay can use the working spouse's income to fund an IRA, if they file taxes jointly.
It is a container
Moving money into an IRA does not invest it. You still choose funds inside the account, or the money sits as cash and barely grows.
There is a yearly limit
You can put in up to $7,500 in 2026, or your pay from work if that is less. People 50 and over can add $1,100 more.
Who an IRA is for
An IRA is for anyone who earns money from work and wants to save for retirement. It is the main option if your job has no 401(k), if you freelance or work gigs, or if you want to save more after getting your 401(k) match.
You can have an IRA and a 401(k) at the same time. Their limits are separate, so using one does not use up room in the other.
How to open one
Pick a brokerage. Online brokerages, some banks and robo-advisers (services that pick funds for you) all offer IRAs. Look for no account fee and low-cost index funds.
You will need your Social Security number, a bank account to link and a beneficiary, the person who gets the money if you die. Then choose the type of IRA, traditional or Roth, and move money in from your bank.
Choosing what goes inside
This is the step people miss. An IRA is the container, and the investments go inside it. When money arrives, it usually sits in a cash holding until you buy something.
Most IRAs let you buy almost any fund, stock or bond the brokerage sells, a much wider choice than a 401(k) menu. More choice can feel like more pressure. A single target-date fund or a broad index fund is a common simple pick. Many brokerages let you set new deposits to buy your chosen fund automatically.
Traditional or Roth
Like a 401(k), an IRA comes in two kinds. A traditional IRA may give you a tax deduction now, and you pay income tax when you take the money out. A Roth IRA gives no break now, and qualified withdrawals in retirement are tax-free.
Each kind has income rules. Whether a traditional IRA is deductible depends on your income and whether you have a plan at work, and Roth IRA contributions phase out at higher incomes. The Roth vs traditional lesson covers how to choose.
An IRA and a 401(k) side by side
Who sets it up: a 401(k) comes from your employer, and an IRA is one you open yourself. How money goes in: a 401(k) takes it from your paycheck, and an IRA takes transfers you set up from your bank.
Yearly limit: $24,500 for a 401(k) and $7,500 for an IRA in 2026. Employer match: only a 401(k) can have one. Investments: a 401(k) offers a short menu, and an IRA offers almost anything the brokerage sells.
Income limits: a Roth 401(k) has none, while a Roth IRA does. Early withdrawals: both usually charge income tax plus a 10% additional tax before age 59½, with some exceptions.
Where an IRA fits in your plan
A common order is to take any 401(k) match first, then fund an IRA, then go back and add more to the 401(k). If you have no workplace plan, the IRA is your first stop.
When you leave a job, you can also move your old 401(k) into an IRA, called a rollover. Your money stays invested in one place you control, with no taxes owed if you move it directly.
Questions people ask
Can I have an IRA and a 401(k) at the same time?
Yes. The limits are separate. If you or your spouse has a workplace plan, your traditional IRA deduction may be smaller at higher incomes, so check the IRS rules.
Can I open an IRA without a job?
You need pay from work, such as wages or self-employment income. If you are married and file jointly, a spouse with little or no income can still contribute based on the other spouse's pay.
Is an IRA the same as a savings account?
No. A savings account holds cash at a bank. An IRA holds investments, and its value goes up and down with the markets.
How much money do I need to open an IRA?
Many online brokerages have no minimum to open one. Some funds have a minimum first purchase, so check before you choose.
Printable worksheet with answer key, free for classrooms. Lesson plan for this unit.
Sources
- IRS: Traditional and Roth IRAs
- IRS: Retirement topics, IRA contribution limits
- IRS: Roth comparison chart
- IRS: Publication 590-A, contributions to IRAs
- IRS: Yearly 401(k) and IRA limit announcement
Updated October 1, 2026. General education, not personalized financial, tax or legal advice. Figures are examples. Check current rates and limits before you act.
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