Will my investment gains be taxed in an IRA?

It depends on the type of IRA.

Traditional IRAs are a common type of IRA with a familiar tax structure you might recognize from other retirement accounts like 401(k)s.

In short, you put money into your traditional IRA before paying taxes on it, which means those contributions may lower your taxable income in the year you make them. The money then grows tax-free until you reach retirement, at which point your withdrawals are taxed as regular income.

Because it’s taxed at withdrawal, traditional IRAs may be the preferred method if you expect to be in a lower income tax bracket later in your life than you are today. Traditional IRAs can also be a good choice for high earners since Roth IRAs have income-based eligibility restrictions that we’ll discuss in a moment.

Plus, tax-deductible contributions get you a tax break in the year they’re made. However, if you or your spouse have access to an employer-sponsored plan, your traditional IRA contributions may not actually be deductible depending on your income. It’s always a good idea to check the latest guidelines from the IRS.

Traditional IRAs, like all retirement accounts, have annual contribution limits. These limits tend to change each year. The IRA contribution limit applies to both traditional and Roth IRAs. In other words, you can have both a traditional and a Roth IRA, but you can only contribute up to the limit across both accounts.

For 2024, the IRA contribution limit is $7,000 if you’re younger than 50, up from $6,500 in 2023. The IRS also allows savers 50 and older to invest extra funds, known as catch-up contributions. If you’re 50 or older, you can invest an additional $1,000, bringing your total contribution to $8,000 in 2024 ($7,500 in 2023).

Traditional IRAs are also subject to required minimum distributions, or RMDs. These are withdrawals you’re obligated to take once you reach age 73. If you fail to take RMDs, you could face a penalty of up to 25% of the required distribution.

Likewise, if you take money out of your traditional IRA before age 59½, you’ll likely face a 10% early withdrawal penalty. There are a few exceptions, though, such as if you’re making what the IRS considers a first-time home purchase.

Roth IRAs are basically the inverse of traditional IRAs: Roth IRA contributions are made with after-tax dollars, which means you don’t get a tax break upfront. But your withdrawals during retirement are tax-free under most circumstances.

That makes Roth IRAs an especially helpful tool for those who expect to be in a higher tax bracket come retirement time. They also tend to be a good choice if you want to spread out your taxes across your lifetime and pay some taxes today to avoid some taxes later.

Unlike traditional IRAs, they are not subject to RMDs during your lifetime if you’re the original account holder. This makes Roth IRAs an especially attractive option if you want to pass down a tax-free inheritance to your heirs after you die.

Roth IRAs have the same annual contribution limits as traditional IRAs. But given their potential tax-free growth, it’s not surprising that Roth IRAs come with a few extra rules.

For starters, Roth IRAs have the following income limits in 2024:

To make the full contribution, you must earn less than:

$146,000 if you’re a single filer ($138,000 in 2023)

$230,000 if you’re married filing jointly ($218,000 in 2023)

To make a partial contribution, you must earn less than:

$161,000 if you’re a single filer ($153,000 in 2023)

$240,000 if you’re married filing jointly ($228,000 in 2023)

If you earn more than these income thresholds, you’re not allowed to directly fund a Roth IRA. There are some ways around this, though, such as a backdoor Roth IRA strategy.

Additionally, Roth IRAs are subject to what’s known as the five-year rule, which is actually a set of five-year rules with some subtle distinctions. The short version, though, is that your Roth IRA must have been open for at least five years to make tax-free withdrawals of earnings, even if you’ve met the other requirements, like reaching age 59 1/2. If you ignore the five-year rule, you may owe income taxes on withdrawals. However, you can always withdraw Roth IRA contributions without owing taxes or a penalty.

The simplified employee pension (SEP) IRA is not as well-known as traditional and Roth IRAs. But for small business owners and self-employed individuals, they can be a game-changer.

SEP IRAs allow independent contractors and small business owners to maximize their retirement savings by making contributions as both the employer and employee. For example, if you’re a small business owner, you can put money into your own SEP IRA, as well as the accounts of employees, including yourself. If you’re an independent contractor, you can put money into your SEP IRA as both employee and employer. However, if you’re employed by a company that offers a SEP IRA, you can’t make contributions on your own behalf.

SEP IRA contribution limits are substantially higher than other IRA annual contribution limits: In 2024, employers may contribute 25% of an employee’s compensation, up to a maximum of $69,000 ($66,000 in 2023). Furthermore, SEP IRA contributions are tax-deductible.

If you’re a small business owner with multiple employees, though, take heed: IRS rules require you to contribute the same percentage of compensation for each qualified worker. Basically, if you contribute 10% of your salary to your own SEP IRA, you’ll also need to contribute 10% of each eligible employee’s salary.

A worker is generally considered an eligible SEP IRA participant if:

They’re at least 21 years old.

They’ve worked for the company for at least three of the last five years.

They’ve earned at least $750 in gross income from that job during the tax year the contributions is made.

Another option for self-employed people and those who run their own companies is the Savings Incentive Match Plan for Employees (SIMPLE) IRA. SIMPLE IRAs are only available to companies with 100 employees or fewer.

With a SIMPLE IRA, employers are required to contribute to employees’ retirement accounts. Employers can either:

Match 3% of employees’ contributions dollar for dollar, OR

Contribute 2% of the employee’s salary (up to $345,000 in 2024) regardless of their elective deferrals.

One of the best things about the SIMPLE IRA is that it’s easy to manage and requires little paperwork compared to other employer-sponsored retirement plans.

However, SIMPLE IRAs also have a potentially pricy quirk: Withdrawals taken within two years of the account opening are subject to an early withdrawal penalty of 25% rather than the typical 10%. The 25% penalty also applies if you roll your SIMPLE IRA into a retirement plan other than a SIMPLE IRA within the first two years.

Still, a SIMPLE IRA can offer workers an incentive to save for retirement, while making it easier for small business owners to offer a retirement plan.