How IRAs work and what advantages they offer

Historically, an IRA, or individual retirement account, is a retirement savings option that you access of your own accord — unlike, say, employer-sponsored options like 401(k) plans or pensions. But in recent years, in an effort to increase Americans' retirement savings efforts, some states have begun to offer IRA enrollment through automatic individual retirement account programs (or auto-IRAs).

These programs "typically require private employers that don't offer workplace retirement plans like 401(k)s to register for state-run plans," and "workers are automatically enrolled in IRAs, often with 3 to 5% of their income deducted from their paychecks," said The New York Times. As of November, such programs are available in 10 states; they will soon be available in seven more, the outlet added, according to the Georgetown University Center for Retirement Initiatives.

You always have the option to open an IRA on your own through a brokerage, bank or credit union. But before you do, it is important to understand how IRAs work and how they compare to other retirement saving options.

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What are IRAs, and how do they work?

IRAs are "retirement accounts for individuals to save pre- or after-tax dollars toward their post-working years" and that, like a 401(k), have "compounding power that can help them grow significantly over time," said Business Insider. A traditional IRA allows your money to grow tax-deferred, meaning you will pay taxes when you withdraw your funds, whereas a Roth IRA allows for tax-free distributions because they are funded with after-tax dollars.

With an IRA, "you contribute funds that can then be invested in a wide range of assets — CDs, stocks, bonds and other top investments," said Bankrate. Unlike a 401(k), you are "not limited to a menu of investments" with an IRA, which "means you can take full control of picking how this account is invested."

However, said Bankrate, "while you can move the money around freely, you may not be able to take it out early without costs," as early withdrawals generally incur penalties. There are also restrictions on how you can contribute to an IRA each year.

While the IRA is "designed primarily for self-employed people who do not have access to workplace retirement accounts such as the 401(k)," said Investopedia, "you can also have an IRA even if you already have a retirement plan at work."

What are the benefits of an IRA?

IRAs can offer a number of advantages. For one, they are "generally more flexible than 401(k)s because they offer a broader range of investment options and greater control over account management," said SmartAsset. Their fees are also "generally lower than 401(k) fees due to the absence of employer-related administrative costs and the ability to shop around for competitive rates."

The tax advantages of IRAs are also notable. "If you contribute to a traditional IRA, you may get a tax deduction on your contributions in the year they are made," said NerdWallet. Meanwhile, though you "do not receive an immediate tax deduction or benefit" with a Roth IRA, "your retirement distributions are tax-free."

Lastly, "IRAs are insured by the Federal Deposit Insurance Corp.," which "covers customer deposits — up to $250,000 per account in most cases — that are held at FDIC-insured banks or savings and loan associations," said Investopedia. This adds a layer of security to your retirement funds.

Is an IRA or a 401(k) better?

The good news here? You don't necessarily have to pick, as you can have both a 401(k) and an IRA.

If you are not ready to start saving doubly and have to choose, a 401(k) "offers more opportunity to increase your retirement savings compared with an IRA, due to the higher annual contribution limits," said NerdWallet. Still, "you could consider investing primarily in an IRA if you don't get an employer match, if you plan to max out your 401(k), or if your 401(k) has narrow investment options or high fees."