MARK RIEPE: I'm Mark Riepe. I head up the Schwab Center for Financial Research, and this is Financial Decoder, an original podcast from Charles Schwab. It's a show about financial decision-making and the cognitive and emotional biases that can cloud our judgment.
The topic this week was motivated by the fact that 2026 is the 45th anniversary of the Economic Recovery Tax Act of 1981. That piece of legislation dramatically expanded access to individual retirement accounts, and those accounts, which I'll call IRAs, is the subject of this episode. IRAs are a vital component of retirement security in the United States. As of the end of 2025, there are $19.2 trillion invested in these accounts.
To put that number in perspective, I was surprised to see that it is nearly double the amount invested in 401(k) accounts, which have $10.1 trillion.1 IRAs matter because they can be a useful part of a retirement savings strategy, but the rules vary depending on the type of IRA you choose. Understanding how IRAs work, including who can contribute, how much you can contribute, and how withdrawals are taxed can help you decide how they may fit into your broader retirement plan.
Time to dive in. Let's start by defining the IRA. An IRA, or individual retirement account, is a tax-advantaged account that can help you save and invest for retirement. Depending on the type of IRA, you may receive a tax benefit either when you contribute or when you withdraw funds. Most IRAs offer a wide selection of investment options such as individual stocks, bonds, mutual funds, exchange-traded funds (or ETFs), and certificates of deposit (also known as CDs).
While it is true that an IRA is a retirement account, don't confuse it with a 401(k) account. Unlike an employer-sponsored retirement plan, such as a 401(k), an IRA is generally opened by an individual through a brokerage firm, bank, or other financial institution. Once the account is open, you can add money to your account, choose how to invest it, and potentially benefit from tax advantages based on the type of IRA you choose. Your contributions, investment choices, taxes, and withdrawals are all subject to IRS rules.
When I use the term IRA, I'm using it to describe a category of account types. By that I mean there isn't just one type of IRA. That matters because once you've decided an IRA is worth investigating, you've then got to decide which type makes the most sense for your situation. There are two main types of IRAs to consider: traditional IRAs and Roth IRAs. The main difference is when you receive the potential tax benefit.
Let me start with traditional IRAs first. Traditional IRAs are generally funded with pre-tax dollars. If your contributions qualify, you can get a tax deduction now, while withdrawals are generally subject to ordinary income tax in retirement. In other words, think of these accounts as tax-deferred accounts, not tax-free accounts. The money that you contribute into the plan isn't taxed now, but under most circumstances, it will be taxed when you pull the money out.
Not all contributions to a traditional IRA are tax deductible. Deductibility can depend on your income and whether you or your spouse is covered by an employer-sponsored retirement plan, such as a 401(k). Also be careful when you pull your money out. Traditional IRAs are subject to required minimum distributions, RMDs for short, and early withdrawals may trigger a 10% U.S. federal tax penalty.
That's a lot of jargon, but just remember that you generally can't pull the money out prior to age 59½, and you must start pulling it out at approximately age 73. As for Roth IRAs, these are funded with after-tax dollars, so you don't receive an immediate tax deduction. However, qualified withdrawals, generally those made after age 59½ and after a five-year holding period, are tax free. Not only that, contributions can generally be withdrawn at any time, tax and penalty free.
Roth IRAs are not subject to required minimum distributions for you as the original owner of the account, but you must meet IRS income limits to contribute. At this point, a logical question is, well, which one makes sense for me? A key thing for you to think about is when do you expect your tax rate to be higher? If you think your tax rate on withdrawals in retirement may be higher than your marginal tax rate today, a Roth IRA may be worth considering because qualified withdrawals in retirement may be tax free.
If you think your tax rate today may be higher than in retirement, a traditional IRA may be more appealing because it may allow you to receive a tax deduction now when you're at the higher rate and pay taxes on withdrawals later at the potentially lower rate. If you expect your tax rate to be about the same, the income tax difference may be less significant. In that case, your decision may come down to other factors, such as whether you want a potential tax break now, tax-free qualified withdrawals later, or more tax flexibility in retirement. If you're not sure about your tax rates, keep in mind that this doesn't have to be an all-or-nothing decision. You can split your contributions between accounts. For example, split the difference. Consider 50% contributed to a Roth and 50% to a traditional IRA. Just remember that the combined contribution can't be over the annual contribution limit.
At this point, I want to take a detour and briefly acknowledge the many other types of IRAs. The first is the rollover IRA. This allows you to move retirement funds from an old employer-sponsored retirement plan, for example, a 401(k), into an IRA. Rolling over your retirement savings in this way may allow you to preserve the tax-deferred status of your retirement assets, thus avoiding taxes or early-withdrawal penalties at the time of transfer.
The second is a SIMPLE IRA. SIMPLE stands for "Savings Incentive Match Plan for Employees." It's a retirement savings plan for self-employed individuals and small businesses with 100 or fewer employees. Employers can make contributions for employees, and employees can also contribute.
The third is the SEP IRA. SEP stands for Simplified Employee Pension. This type of IRA is another way for self-employed individuals and business owners to set up a retirement savings plan for themselves and their employees. These accounts are funded by the employer, and contribution limits are generally higher than traditional or Roth IRA limits.
Number four is the inherited IRA. This is also known as the beneficiary IRA. This type is open when someone inherits a retirement account after the death of the original owner. Number five is the custodial IRA. This is a traditional IRA or Roth IRA opened by a parent, grandparent, or other custodian for a minor who has earned income for the year. The minor assumes ownership of the account when they reach the age of adulthood determined by state law. Number six is the spousal IRA. This allows a working spouse to fund a traditional IRA or Roth IRA for a spouse who doesn't have earned income. To qualify, the couple must file a joint tax return.
Now we're back on the main road and I want to talk about contributions. Not everyone can contribute to a traditional or Roth IRA. You generally need taxable compensation such as wages, salaries, tips, commissions, bonuses, or self-employment income. Your annual IRA contribution for the year generally can't exceed your taxable compensation or the annual IRA contribution limit, whichever is lower.
Don't worry if you're getting up in years, there is no age limit to contribute to a traditional or Roth IRA, as long as you have taxable compensation. One exception to all this is the spousal IRA that I mentioned earlier. It may also allow a working spouse to contribute to an IRA for a spouse with little or no income if the couple files a joint tax return and meets IRS eligibility rules. There's also a lot of fine print with the other niche IRA types that are mentioned earlier, so be sure to examine the details for those.
Before I leave the topic of contributions, I want to expand on the point around IRA contribution limits. These are complicated, and I'm not going to read a bunch of numbers to you. At the end of the podcast, I'll give you some resources where you can get the details. For now, I want you to remember the following.
First, annual contribution limits can change from year to year and vary by IRA type. Second, for traditional and Roth IRAs, the annual limit applies across your combined accounts. Third, as I mentioned earlier, your total annual IRA contribution also can't exceed your earned income for the year. Fourth, Roth IRA contributions may be reduced or eliminated if your income exceeds certain IRS limits. Fifth, the limits can also vary by age. Like I said, we've got resources where you can get the specific numbers, but to give you some sense as to the limits, in 2026, the total maximum contribution for traditional and Roth IRAs is $7,500.
Now I want to talk about deductions. The first thing to understand is that traditional IRA contribution limits and deduction limits are not the same. You may be able to contribute to a traditional IRA even if you can't deduct the full contribution. Your ability to deduct traditional IRA contributions depends on your modified adjusted gross income, MAGI for short, your tax-filing status, and whether you or your spouse is covered by a workplace retirement plan.
If you or your spouse is covered by such a plan, deductions are generally fully available below the phased-out range, partially available within the phase-out range, and unavailable once your MAGI reaches or exceeds the top of the range. If neither you nor your spouse is covered by a workplace retirement plan, your traditional IRA contribution is generally fully deductible up to the annual contribution limit.
For the Roth, it's a little bit different. Remember that Roth IRA contributions are not tax deductible. Your ability to contribute to a Roth IRA depends on your MAGI and tax-filing status. In general, you can make a full contribution below the phased-out range, a reduced contribution within the phase-out range, and no contribution once MAGI reaches or exceeds the top of the range.
No one wants to hear me endlessly read numbers, so we'll have links at the end of the show to articles that provide those phase-out ranges. One more thing before I move on. These income limits apply to direct Roth IRA contributions. If your income is too high to contribute directly to a Roth IRA, you may be able to use a backdoor Roth IRA strategy. This generally involves making a non-deductible contribution to a traditional IRA and then converting those assets to a Roth IRA. However, this strategy can have tax consequences, so consider speaking with a tax advisor before using this approach.
It's time for me to wrap up. First, I want to acknowledge that I've never met a Financial Decoder listener who just listens to an episode. Every single listener tells me about all the other stuff they do while listening. Given that reality, there's a good chance you won't remember all of what I just covered. So do me a favor and make sure you just remember these points.
One, an IRA is a tax-advantaged investment account that can help you save and invest for retirement. Two, you generally need earned income to contribute to an IRA. Three, contribution limits vary by IRA type, and traditional and Roth IRA limits apply across your combined contributions to both accounts. Four, different types of IRAs offer different tax benefits, eligibility rules, and withdrawal requirements. Number five, traditional IRAs may offer tax deduction now, while Roth IRAs may offer tax-free qualified withdrawals later.
I have just barely scratched the surface of this important topic, so please go to schwab.com/IRA. It has a ton of great information on IRA accounts, the mechanics of how to open one if you think it's right for you, and an excellent FAQ section. We also have many in-depth articles on this topic. A good place to start is one by Hayden Adams entitled "What Is an IRA?" that you can find at schwab.com/learn. What I particularly like about it are the comparison tables where it stacks up traditional vs. Roth side by side on various dimensions to help you make a better decision. He also touches on some of the big picture issues that matter when you withdraw money from your IRA. He's got tables showing the different contribution limits and phase-out thresholds.
Thanks for listening today. If you'd like to hear more from me, you can follow me on my LinkedIn page at X @MarkRiepe. That's M-A-R-K-R-I-E-P-E. As always, we'd appreciate it if you give us a rating or review on Apple Podcasts or comment on the show if you listen to it on Spotify. We always like new listeners, so if you have a friend or two who might like the show, please tell them about us and how they can follow us for free in their favorite podcasting app.
For important disclosures, see the show notes and schwab.com/FinancialDecoder.
^Investment Company Institute. (2026, March 26). ICI data shows retirement assets total $49.1 trillion in fourth quarter 2025. https://www.ici.org/news-release/26-news-ret-q4-2025