What is a traditional IRA?
A traditional IRA (Individual Retirement Account) is a type of retirement savings account. Traditional IRAs allow individuals to contribute pre-tax income towards investments that can grow tax-deferred. This means that the money you contribute to a traditional IRA is not taxed until you withdraw it during retirement. The primary benefit of this tax-deferred growth is that it can allow your investments to increase in value by compounding over time without being reduced by taxes each year.
Everyone with earned income in a given year can contribute to a traditional IRA, and some or all of those contributions may be tax-deductible, described below.
How traditional IRA contributions work
For the 2024 tax year, the contribution limit to all your IRAs (both traditional and Roth for a traditional IRA is $7,000 for individuals under the age of 50. If you are 50 or older, you can make an additional catch-up contribution of $1,000, bringing the total limit to $8,0001. These limits are subject to change, so it's important to stay updated on the latest contribution limits set by the IRS.
Contributions to a traditional IRA can be made regardless of your income level, as long as you have earned income. However, the tax deductibility of your contributions may depend on your income and whether you or your spouse are covered by an employer-sponsored retirement plan. For example, if you are covered by a retirement plan at work, your ability to deduct contributions to a Traditional IRA may be limited based on your income2.
Additionally, a traditional IRA can be established by transferring assets (“rolled over”) from an eligible retirement account, such as 401(k) account3.
Tax benefits and withdrawals with traditional IRAs
One of the key advantages of a traditional IRA is the potential for tax-deductible contributions. If you qualify, you can deduct your contributions from your taxable income, which can lower your overall tax bill for the year.
It's important to note that withdrawals from a traditional IRA are subject to income tax. When you withdraw money from your traditional IRA during retirement, the amount you withdraw will be taxed at your income tax rate at that time. Additionally, if you withdraw funds before the age of 59½, you may be subject to a 10% early withdrawal penalty, unless you qualify for an exception4.
Required Minimum Distributions (RMDs)
Another important aspect of traditional IRAs is the requirement to take minimum distributions currently starting at age 735. These “required minimum distributions” (RMDs) are calculated based on your account balance and life expectancy. Failing to take your RMDs can result in financial penalties, so it's important to understand and comply with these requirements.
Investing the funds in your traditional IRA
Traditional IRAs offer a range of investment options, including stocks, bonds, mutual funds, and ETFs. The flexibility to choose from various investment vehicles allows you (or your financial advisor) to tailor your investment portfolio to align with your risk tolerance and retirement goals. It’s also important to diversify your investments to manage risk and potentially maximize returns.
Retirement Benefits
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How to decide if a traditional IRA right for you
Deciding whether a traditional IRA is the right choice for your retirement savings depends on your individual financial situation and goals. If you expect to be in a lower tax bracket during retirement, the tax-deferred growth and potential tax deductions of a traditional IRA can possibly be beneficial. However, if you anticipate being in a higher tax bracket, you might want to consider other retirement savings options, such as a Roth IRA, which offers tax-free withdrawals in retirement.
A traditional IRA is a powerful tool for retirement savings, offering the opportunity for tax-deferred growth over time and potential tax deductions in the short-term. Remember to stay updated on any IRA rule changes regarding contribution limits and RMD requirements to maximize the benefits of your traditional IRA.
It's always a good idea to consult with a financial advisor to determine the best retirement strategy for your individual situation.
