An individual retirement account (IRA) is simply an account that allows you to make contributions for the purpose of saving for retirement. The contributions to these accounts are either tax-deferred or tax-exempt. With tax-deferred accounts like the traditional IRA, you can claim a deduction for amounts contributed to your IRA, thereby reducing your taxable income in a given year up to the IRA contribution limits set by the Internal Revenue Service (IRS). When you start withdrawing funds from a traditional IRA in retirement, however, these distributions are taxable income. 

With tax-exempt IRAs, like the Roth IRA, you contribute after tax-dollars that aren’t taxed when withdrawn in retirement. If you are expecting to have a large income in retirement due to other investment portfolios, cash flowing assets, company pensions, and so on, then a tax-exempt IRA becomes a more attractive retirement vehicle even though it doesn’t provide an immediate tax deduction through your current contributions. 

There are many flavors of individual retirement accounts, as well as spousal and custodial IRAs. Choosing between them for most people will come down to whether you qualify for and want a tax deduction now (traditional IRA) or you want tax-free distributions in retirement instead (Roth IRA). These two types of IRA are available from all the brokers mentioned above. Choosing between them depends on whether you are covered by other plans or expect to have a high income into retirement. 

There are also some IRA types that are meant for people who run businesses. The simplified employee pension (SEP) IRA allows an employer to set up IRAs for themselves and their employees. As the name implies, this type of IRA is simplified to allow for easy administration and flexible contributions. Savings incentive match plan for employees (SIMPLE) IRAs are also available for employers where a traditional 401(k) plan isn’t an option, but the business owner wants something more formal than a SEP IRA. Last, a solo 401(k) is meant for business owners who don’t have employees and allows them to make both the employer and employee contributions to the plan to maximize contributions and deductions.

If you aren’t running a business, however, you are most likely going to be opening either a Roth IRA or a traditional IRA depending on your personal financial situation.

The most common question when it comes to IRAs is whether you can deduct it on your taxes. The short answer is that contributions to a traditional IRA are tax-deductible in the year they are made and the money grows tax-deferred. For 2022, your traditional IRA contribution limit is $6,000 ($7,000 if you are 50 or older). The limit rises to $6,500 for 2023 ($7,500 if you are 50 or older.

The deduction you can claim depends on your modified adjusted gross income (MAGI), your marital status, and whether you are covered by another plan at work.

Contributions to a Roth IRA are tax-exempt, not tax-deductible or tax-deferred. The contribution limits on the Roth IRA are the same as a traditional IRA, but the contributions cannot be used to reduce your taxable income at all. Instead, the money you put in a Roth IRA is after-tax dollars that can later be withdrawn tax-free as long as you follow the requirements (essentially that the Roth IRA has been accumulating for more than five years and you are over 59 and a half when you make the first distribution).

Simply put, a tax-deductible IRA is one where you can reduce your taxable income in a given year by making contributions, but you will have to claim the distributions in retirement as taxable income—you are deferring the taxes instead of eliminating them. A tax-exempt IRA is one where you contribute after-tax dollars without receiving a deduction and instead are able to receive tax-free distributions in retirement.

Many people save for retirement using 401(k) plans through an employer or an IRA they have set up themselves that matches their employment situation. That said, there are alternatives to IRAs. Some people use health savings accounts (HSA) to remove one known cost in retirement and make their other accounts go further in old age. If taxation is not a major concern or you've exceeded your contribution space, then you can look at normal taxable brokerage accounts, trusts and custodial accounts, real estate, and other stores of value to hold your wealth.