The purpose of an IRA is to create a retirement account that compounds funds faster than in a taxable account. Depending on the type of account, IRA funds may compound tax-exempt. IRA owners can also generate additional earnings on interest, capital gains, and dividends. An IRA either allows tax-free interest or defers taxes until you take withdrawals. You generally cannot make withdrawals before age 59 ½ without incurring a 10% tax penalty on the amount withdrawn, but there are a few exceptions, which we cover in the next section.
The two main types of IRAs provide different benefits. A traditional IRA brings the advantage of tax deferral, allowing the account holder to reduce their taxable income while growing their income for retirement. Roth IRAs allow tax-free withdrawals and earnings. IRAs also open several investment opportunities, enabling account holders to use their tax-advantaged funds to generate more revenue.