How Does an IRA Work? An IRA (Individual Retirement Account) is one of the most flexible and widely used retirement tools in the U.S. because it allows you to save and invest money with major tax advantages. Depending on the type of IRA you choose, you may be able to lower your taxable income today (Traditional IRA) or create tax-free retirement withdrawals later (Roth IRA). The biggest value of an IRA is that it gives you long-term control over how your retirement money is invested, when you access it, and how you convert it into income.

For many people, an IRA becomes the “landing zone” for retirement money after changing jobs, selling a business, or retiring. It’s common for an IRA to eventually hold funds rolled over from a 401(k), 403(b), TSP, pension plan, or other employer plan—especially when someone wants easier account management and clearer retirement income planning. If you’re moving money from an employer plan, the cleanest approach is typically a direct rollover, which helps keep the move tax-free and paperwork-correct.

At Diversified Insurance Brokers, we work with clients nationwide who use IRAs for three main purposes: (1) long-term tax-advantaged growth, (2) consolidation of old retirement accounts, and (3) building retirement income they can’t outlive using tools like annuities. This page explains how an IRA works from start to finish—rules, limits, strategies, and what people do as retirement gets closer.

If you’re here because you’re trying to decide what your IRA should actually do for you (growth, income, lower taxes, safer structure), this guide will walk you through the full picture in plain English.

What Is an IRA (and Why So Many Retirees Use One)?

An IRA is a retirement account you open outside of your employer. Unlike a workplace plan that is controlled by your company’s benefits department, an IRA is owned by you personally and typically held at a custodian such as a bank, brokerage firm, or insurance company. That means you can choose how it’s invested, how it’s managed, and how it fits into your long-term plan.

People often assume IRAs are only for “small contributions each year,” but for many households, the IRA becomes the single largest retirement account they own—especially after rolling over funds from multiple employers. A person who changes jobs three or four times can easily end up with multiple 401(k)s and 403(b)s. Consolidating those into one IRA can simplify the strategy and create a clearer path for retirement income planning.

Another reason IRAs are so popular is flexibility. The account can be invested for growth, positioned conservatively for stability, or structured for predictable income. In many cases, an IRA becomes the staging area for turning retirement savings into income using contract-based solutions like fixed annuities or fixed indexed annuities. If you’re exploring guaranteed income mechanics, a useful reference point is guaranteed income from annuities.

In short, an IRA is not just an “account.” It’s a container for tax advantages and retirement planning decisions. How it works depends on what type you have, how you fund it, and how you eventually distribute it.

Traditional vs. Roth IRA: How the Two Main IRA Types Work

The two most common IRA types are the Traditional IRA and the Roth IRA. Both give you tax advantages, but they work in opposite directions. Think of it like choosing whether you want a tax benefit now versus a tax benefit later.

Traditional IRA contributions may be tax-deductible (depending on your income and whether you’re covered by a workplace plan). The growth inside the account is tax-deferred, and withdrawals are generally taxed as ordinary income. Traditional IRAs are also subject to Required Minimum Distributions (RMDs) later in life. For many people, that means the account eventually becomes a taxable income source whether they “need” the money or not.

Roth IRA contributions are made with after-tax dollars, meaning you don’t get a deduction now. The benefit is that qualified withdrawals can be tax-free later. Roth IRAs also have a major planning advantage: they generally do not have RMDs during the original owner’s lifetime. This makes Roth accounts powerful for long-term tax control and legacy planning.

Many high-income savers end up using both types over time. A common strategy is to contribute to a Traditional IRA during peak earning years to reduce taxable income (or roll over pre-tax employer plan dollars into a Traditional IRA), and then build Roth assets when it makes sense from a tax perspective.

If you’re trying to balance taxes, income, and stability, IRAs can also be paired with conservative income strategies. For example, some clients explore fixed indexed annuity concepts as part of building downside-protected income alongside their IRA plan.

How IRA Contributions Work (Limits, Eligibility, and Timing)

An IRA can be funded in multiple ways. The most common method is an annual contribution based on earned income. The IRS sets yearly contribution limits, and those limits can change over time. Contributions are typically made from cash in your bank account, and then invested inside the IRA based on your chosen strategy.

Contribution rules matter because they determine whether you can add money at all, how much you can contribute, and whether the contribution is deductible (Traditional) or subject to income limitations (Roth). For most people, the practical importance is this: your IRA has rules, but your planning should focus on maximizing tax advantages without creating future restrictions or penalty risks.

Even if you already have a large IRA from rollovers, annual contributions can still add value. They can also help you build flexibility between Traditional and Roth assets. Some households use IRAs to create “tax diversification,” meaning they can choose from multiple buckets in retirement depending on the tax landscape at that time.

For couples, IRA strategy can also be extended through a spouse. In many cases, a non-working spouse can still fund an IRA using spousal contribution rules, as long as the couple meets earned income requirements and files appropriately. This can be one of the easiest ways for a household to increase tax-advantaged savings over time.

What Can You Invest In Inside an IRA?

One of the biggest misconceptions about IRAs is that the IRA itself is an “investment.” It’s not. The IRA is the account wrapper. Inside the IRA, you choose the investments. Depending on the custodian, your IRA can hold stocks, bonds, ETFs, mutual funds, CDs, money market options, and sometimes insurance-based solutions like fixed annuities or indexed annuities.

The freedom to invest is a benefit, but it also creates a responsibility: your IRA performance depends on what you select and how it aligns with your timeline. Someone who is 35 years old might use an IRA primarily for growth and long-term compounding. Someone who is 62 might be far more focused on stability, income planning, and protecting the principal they’ve already accumulated.

Many retirees eventually become less interested in “beating the market” and more interested in building predictable retirement cash flow. That’s often where annuities enter the discussion. Within a qualified IRA strategy, annuities can provide contract-defined income potential while keeping the retirement account tax-deferred. If you want to see how liquidity can work with contract-based products, one helpful overview is annuity free withdrawal rules.

In other words, you can invest your IRA for growth, you can invest it for stability, or you can invest it for income. The best approach depends on what you need the IRA to do in the next 5, 10, and 20 years—not just what you want it to do in the next 12 months.

How IRA Rollovers Work (401(k), 403(b), TSP, and Pension Rollovers)

One of the most important reasons people open an IRA is to roll money into it. A rollover is when retirement funds are transferred from one account type to another—most often from a workplace plan into an IRA. This is common when someone changes jobs, retires, or wants to consolidate old accounts into one strategy.

The cleanest rollover method is typically a direct rollover, which moves the money from one custodian directly to another. This avoids withholding issues, avoids accidental taxable distributions, and generally keeps your retirement money “qualified” the entire way. If you’re unfamiliar with the mechanics, start here: What is a direct rollover?

Rollovers can also be important because employer plans often have limited investment menus. Many 401(k)s and 403(b)s are restricted to a pre-set list of funds. When you roll into an IRA, you typically gain broader flexibility. That flexibility can be especially useful when the goal shifts from accumulation to distribution and retirement income planning.

Employer plans also differ from each other operationally, which is why many retirees end up searching for answers like How does a 401(k) work? or How does a 403(b) work? before deciding whether rolling into an IRA simplifies their next steps.

A major advantage of the IRA rollover stage is that it becomes a decision point. Instead of leaving money “where it is,” you get to evaluate what your retirement money should do next—more growth, less volatility, guaranteed income, better liquidity control, or simply easier management.

Direct vs. Indirect Rollovers (Why the Difference Matters)

A direct rollover is usually the simplest and safest approach because the money moves from the old custodian directly to the new custodian. The check is often made payable to the receiving institution “for the benefit of” the account owner, or the transfer is handled electronically when available.

An indirect rollover is when the money is paid to you personally first, and then you redeposit it into a new IRA within the allowed time window. This can create problems, especially if taxes are withheld or paperwork is handled incorrectly. In many cases, indirect rollovers are responsible for avoidable tax bills and frustration—because missing a deadline can turn a rollover into a taxable distribution.

When someone is rolling over a large retirement account, the goal is usually to keep the move tax-free and clean. This is why most retirement income planning is built around direct rollovers and trustee-to-trustee transfers wherever possible.

How IRA Taxes Work (What Gets Taxed and When)

The tax treatment of an IRA depends on what type of IRA you have and what type of money is inside it. Most rollover IRAs consist of pre-tax funds that came from employer plans, which means withdrawals are generally taxed as ordinary income. This is important because IRA withdrawals stack on top of other income sources during retirement.

If you have multiple income streams—Social Security, pension payments, rental income, part-time consulting income, or withdrawals from other accounts—your IRA distributions can become the factor that pushes you into higher tax brackets. This is why IRA planning is not only about investment performance. It’s also about income control and tax bracket control.

Roth IRAs work differently. Roth withdrawals can be tax-free if rules are met, which can make them valuable during years where you want to keep taxable income lower. A blended strategy that includes both Traditional and Roth assets can give retirees flexibility to manage income and taxes strategically over time.

Many people also want to know how annuities interact with IRA taxes. Generally speaking, if you purchase an annuity inside an IRA, the tax treatment follows IRA rules because the IRA is the tax wrapper. That means distributions are still taxed as IRA distributions (for pre-tax money), but the annuity may change how the income is structured and how predictable it becomes.

Required Minimum Distributions (RMDs) and Why They Matter

Most Traditional IRAs eventually require you to take Required Minimum Distributions (RMDs). RMDs are the IRS’s way of ensuring tax-deferred retirement money is eventually taxed. Once you reach the applicable RMD age, you must begin taking a minimum amount each year based on IRS life expectancy tables and your prior-year account balance.

RMDs matter because they remove some of your flexibility. Even if you don’t “need” the money, you still need to take the distribution. That means RMDs can increase taxable income in later retirement years, which can affect overall tax planning, Medicare premiums for some retirees, and the way income sources interact.

If you want a broader explanation of how the SECURE changes impact distribution planning and timing, this page is a strong companion resource: RMDs after SECURE 2.0.

For some households, the best IRA strategy isn’t only about investing. It’s about coordinating distributions so they occur intentionally instead of being forced later. This is also where Roth conversions may come into play for certain situations.

How People Turn an IRA Into Retirement Income

Eventually, most IRAs shift from “growth mode” to “income mode.” The goal changes from accumulating a large balance to generating retirement income that can support spending, lifestyle, and financial security. That transition often creates the most important IRA questions: How much can I safely withdraw? How do I avoid market losses right before or during retirement? What happens if I live longer than expected?

Many retirees use a systematic withdrawal approach, pulling a set amount each year from an invested IRA portfolio. That can work well, but it can also create risk if the market declines early in retirement. This is commonly referred to as “sequence of returns risk,” and it’s one reason many people explore adding predictable income sources into the plan.

Annuities can be used inside IRA strategies to help create contract-based income options. Instead of relying entirely on market withdrawals, a retiree can position a portion of IRA assets into a guaranteed-income design, and leave the remaining portion for growth or liquidity. If you want an overview of how predictable income can work, see guaranteed income from annuities.

Retirement income planning is not about “all or nothing.” It’s about building a mix of resources that can perform in different environments: market growth, market downturns, inflation changes, and longevity. The IRA is often the account where those decisions get implemented.

Using Annuities Inside an IRA (How It Works in Real Life)

When someone uses annuities with an IRA, the typical approach is simple: the IRA remains the qualified account structure, and the annuity becomes the retirement-income tool inside it. The most common reason people consider this is stability. A fixed annuity can provide principal protection and contract-defined interest. A fixed indexed annuity can provide downside protection with potential index-linked growth. Income riders can be added in some cases to create a clearer retirement paycheck framework.

For retirees who want predictable lifetime income, annuities can help convert a portion of the IRA balance into an income stream designed to last for life. This can reduce pressure on the rest of the IRA and allow the remaining portion to stay invested for longer-term growth or legacy planning.

Another reason annuities show up in IRA discussions is liquidity planning. Many annuity designs include “free withdrawal” provisions, which allow a certain percentage of the account value to be accessed annually without surrender charges. This can be helpful when someone wants both stability and flexibility. If you want a deeper look at how that works, see annuity free withdrawal rules.

Some people also evaluate annuities during rollover windows because they want to reduce the chance of missing a market recovery after a downturn. In those cases, a fixed strategy can provide a more controlled experience. This is one reason people often research whether annuities are actually worth it: Are annuities worth it?

How to Transfer IRA Money to an Annuity (The Clean Way)

When someone decides to reposition IRA money into an annuity, the best method is typically a trustee-to-trustee transfer. This keeps the IRA qualified and avoids triggering taxation. The process can be simple when done correctly: your IRA custodian moves funds directly to the insurance company issuing the annuity, and the annuity is titled as a qualified IRA annuity.

The key is paperwork accuracy. The money should not be distributed to you personally. It should be moved directly between institutions to preserve tax deferral and avoid accidental taxable events. If you want the full mechanics explained, this guide lays it out clearly: How to transfer an IRA to an annuity.

At the time of publication, many retirees use this approach specifically to create dependable income and reduce exposure to volatility. The exact design depends on age, goals, liquidity needs, and whether the priority is fixed interest, index-linked growth potential, or lifetime income.

Common IRA Mistakes That Cost People Money

IRAs are powerful, but mistakes can be expensive. One of the most common issues is treating the IRA like a “set it and forget it” account without considering how it will be used in retirement. The investment strategy you use at age 40 is rarely the same strategy you should use at age 65. As retirement approaches, the risk profile changes, and the consequences of a market decline can become more severe.

Another frequent mistake is poor rollover execution. Accidentally triggering taxes during a rollover, missing deadlines, or using the wrong transfer method can create avoidable taxable events. This is why direct rollovers are usually preferred. Again, this page is the baseline reference: direct rollover basics.

Finally, many people underestimate how much taxes can shape retirement outcomes. The IRA is often one of the largest sources of taxable income in retirement. Without a plan, IRA withdrawals can cause “tax spikes,” which can reduce net income and create frustration even when the account performed well overall.

What Happens to an IRA When You Die? (Beneficiaries and Inherited IRAs)

IRAs are not just retirement accounts—they are also part of your legacy plan. When an IRA owner passes away, the account typically transfers to named beneficiaries, and the rules shift to inherited IRA guidelines. Those rules can be very different from the rules for your own IRA.

Inherited IRA planning matters because timelines and tax rules can accelerate distributions. Many beneficiaries are surprised by how quickly the IRS expects inherited retirement money to be distributed. This can create tax issues if not managed intentionally—especially for high earners who inherit significant IRA balances.

If you want the full breakdown of inherited IRA rules, timelines, and how beneficiaries plan distributions, this resource is a strong next step: How does an inherited IRA work?

Some retirees also care deeply about beneficiary protection features. Depending on the strategy used, certain annuity structures may include built-in or optional features designed to protect beneficiaries. This overview can help clarify the concept: annuity beneficiary death benefits.

Why Many People Consolidate Multiple Accounts Into One IRA

As careers evolve, it’s common for people to accumulate multiple retirement accounts. A previous employer’s 401(k), a current employer plan, a rollover IRA, maybe a small SEP IRA from a side business—over time, it can become difficult to track everything and manage the bigger picture.

Consolidating accounts into one IRA can simplify decision-making. It can also reduce paperwork, make investment strategy clearer, and help with retirement income planning because you have a single view of what your savings can realistically produce.

Another advantage is that consolidation can make beneficiary planning easier. Instead of updating beneficiaries across multiple custodians, many people prefer to centralize assets for cleaner legacy execution.

However, consolidation isn’t automatically “right” for everyone. Some workplace plans have unique features, investment access, or creditor protection rules that may be valuable. The key is evaluating the pros and cons before making changes.

How an IRA Fits with Other Retirement Accounts

Most households don’t rely on an IRA alone. IRAs often work alongside 401(k)s, 403(b)s, pensions, Social Security, brokerage accounts, and sometimes annuity-based income plans. The key is coordinating how income will be generated across these sources so that cash flow is reliable and taxes are managed intentionally.

This coordination becomes especially important once retirement begins. The order in which you take income can matter. Taking too much from taxable accounts early can reduce flexibility later. Taking too much from pre-tax IRAs too quickly can create bracket pressure. Building a “layered” plan with multiple types of income and tax treatments can make retirement feel more stable.

For many retirees, the IRA becomes the main account used for income planning because it holds the largest consolidated balance. That’s why understanding how an IRA works is more than a technical topic—it’s a practical one.

When Should You Review Your IRA Strategy?

If you’re early in your career, reviewing your IRA strategy is often about contribution consistency, investment selection, and long-term compounding. The goal is growth and disciplined accumulation.

If you’re within 10 years of retirement, reviewing your IRA becomes more about risk reduction, income planning, and ensuring that your withdrawals won’t be overly dependent on market conditions. This is often the stage where people begin exploring fixed and indexed annuity strategies inside an IRA to create stability while still keeping a portion invested for growth.

If you’re already retired, the review should focus on distribution efficiency, taxes, RMD planning, and whether your income sources feel dependable. Some retirees discover that their biggest concern isn’t market performance—it’s simply whether their income plan is predictable enough to support the lifestyle they want without constant worry.