So how does an IRA work? Investments held in IRAs can encompass a range of financial products, including stocks, bonds, ETFs, and mutual funds. A self-directed IRA can be a traditional IRA or a Roth IRA. Self-directed IRAs allow investors to make all the decisions and give them access to a broader selection of investments, including real estate, private placements, and tax liens.
Individual taxpayers establish traditional and Roth IRAs, while small-business owners and self-employed individuals set up SEP and SIMPLE IRAs. An IRA must be opened with an institution that has received Internal Revenue Service (IRS) approval to offer these accounts. Choices include banks, brokerage companies, federally insured credit unions, and savings and loan associations. Most individual investors open IRAs with brokers.
Note that you can only contribute to an IRA with earned income that meets IRA rules. Income from investments, Social Security benefits, or child support does not count as earned income.
Because IRAs are meant for retirement savings, there is usually an early-withdrawal penalty of 10% if you take money out before age 59½. Depending on what type of IRA you have, you may also need to pay income tax on your early withdrawal.