Table of Contents
- What Is a Traditional IRA?
- Key Takeaways
- How Traditional IRAs Work
- Traditional IRAs and 401(k)s or Other Employer Plans
- Traditional IRA Distributions
- Traditional IRAs vs. Other IRA Types
- Opening a Traditional IRA
- Retirement Security Rule: What It Is and What It Means for Investors
- What Is the Difference Between a Traditional IRA and a Roth IRA?
- What Are the Rules for a Traditional IRA?
- What Are the Different Types of IRAs?
- What Are the Disadvantages of Traditional IRAs?
- Does a Traditional IRA Grow Tax-Free?
- The Bottom Line
What Is a Traditional IRA?
I'm here to explain what a traditional IRA really is. It's a retirement account where you deposit pre-tax contributions, and the investments grow tax-deferred until you withdraw the money in retirement.
A traditional individual retirement account, or IRA, lets you put pre-tax income into investments that grow without taxes on capital gains or dividends until you take the money out. You can contribute from your qualified earned compensation, and there's no income limit to open one, but deductions might be restricted based on your income, filing status, and other factors. You can set this up through a broker, online platform, or financial advisor.
Key Takeaways
Let me break down the essentials for you. With a traditional IRA, you contribute pre-tax dollars to a retirement account where investments grow tax-deferred until you withdraw them in retirement. Those withdrawals get taxed at your income tax rate for that year. You need to stick to annual contribution limits and watch the required minimum distribution schedules. If you pull money out before 59½ without qualifying for an exception, you'll face income tax plus a 10% penalty. Unlike Roth IRAs, these contributions are deductible from your current taxable income.
How Traditional IRAs Work
Traditional IRAs work by letting you contribute pre-tax dollars to an investment account that grows tax-deferred until you start withdrawals at 59½ or later, when they become taxable income. If you withdraw early, you hit a 10% penalty unless you qualify for an exemption. Custodians like banks or brokers hold the account and invest based on your instructions and their options.
In most cases, your contributions are tax-deductible. For example, if you put in $7,000, you can deduct that from your income tax return, so the IRS doesn't tax those earnings upfront. But when you withdraw in retirement, it's taxed at your ordinary income rate for that year.
The IRS sets annual limits based on age: $7,000 for under 50 in 2024 and 2025, plus $1,000 catch-up for 50 and older, making it $8,000. Thanks to the SECURE Act of 2019, there's no age limit on contributions if you have taxable earned income like wages or self-employment earnings, up to the annual cap.
Traditional IRAs and 401(k)s or Other Employer Plans
If you have a traditional IRA and an employer plan like a 401(k), the IRS might limit your deductible contributions. For singles in 2024, full deduction is available if your MAGI is $77,000 or less ($79,000 in 2025); for married filing jointly, it's under $123,000 in 2024 ($126,000 in 2025). No deduction at $87,000 for singles in 2024 ($89,000 in 2025) or $143,000 for couples ($146,000 in 2025), with phase-outs in between.
You must make contributions by the tax filing deadline, usually around April 15 of the following year. Remember, taxes on IRA money are paid at withdrawal, based on your retirement tax bracket, so this is ideal if you expect a lower bracket then.
Traditional IRA Distributions
Distributions from a traditional IRA are treated as ordinary income and taxed accordingly. You can start without penalty at 59½. RMDs depend on your birth year: 70½ if born before July 1, 1949; 72 if July 1, 1949, to December 31, 1950; 73 if January 1, 1951, to December 31, 1959; 75 if 1960 or later. Take them by December 31 each year, except the first one by April 1 after turning 73.
Early withdrawals before 59½ get a 10% penalty plus taxes, but exceptions apply for things like first-home purchases up to $10,000, disability, death, unreimbursed medical expenses, SEPP programs, education or adoption costs, job loss medical insurance, IRS levies, nondeductible contributions, or military reservist duty over 179 days. Consult a tax pro or the IRS to confirm your situation qualifies.
Exceptions to Early Withdrawal Penalty
- Using the distribution for purchasing or rebuilding a first home for you or a qualified family member, limited to $10,000 lifetime.
- Becoming disabled before the distribution.
- Beneficiary receiving assets after your death.
- Unreimbursed medical expenses.
- Substantially equal periodic payment (SEPP) program.
- Higher education expenses or costs for having or adopting a child.
- Medical insurance after job loss.
- IRS levy.
- Return of nondeductible contributions and attributable income.
- Military reservist called to active duty for more than 179 days.
Traditional IRAs vs. Other IRA Types
Other IRAs include Roth, SIMPLE, and SEP. SIMPLE and SEP are employer-based, popular for small businesses, while you can set up a Roth if you meet income limits through a broker.
With Roth IRAs, contributions aren't deductible; you use after-tax dollars, but qualified distributions are tax-free. You can withdraw contributions anytime penalty-free, and earnings after 59½ if the account is five years old. No RMDs, and you can pass it to heirs. Limits are the same as traditional: $7,000 or $8,000 with catch-up, but phased out for high earners—singles $146,000-$161,000 in 2024 ($150,000-$165,000 in 2025), couples $230,000-$240,000 ($236,000-$246,000).
SIMPLE and SEP IRAs are for employers or self-employed. SEPs allow employer contributions only, deducted by the employer, with immediate vesting. SIMPLEs let employers contribute 2% or match up to 3%, with employee limits of $16,000 in 2024 ($16,500 in 2025) plus $3,500 catch-up.
Opening a Traditional IRA
You can open a traditional IRA if you or your spouse has taxable compensation and you file jointly. Both can open separate ones if eligible. Use financial institutions or brokers like Fidelity or Vanguard; they handle IRS requirements. Contribute via cash, check, or money order—no physical property. No minimum balance needed.
Retirement Security Rule: What It Is and What It Means for Investors
If you're using an advisor for your IRAs, know the Retirement Security Rule from the DOL, effective September 2024 with some delays to 2025. It protects against conflicts by requiring fiduciaries under ERISA to give best-interest advice, not just suitable, limiting what they can sell.
What Is the Difference Between a Traditional IRA and a Roth IRA?
The main difference is tax treatment: Traditional contributions are deductible, grow tax-deferred, and withdrawals are taxable; Roth contributions aren't deductible but grow tax-free, with tax-free withdrawals if rules are met.
What Are the Rules for a Traditional IRA?
Rules include annual contribution maxes, RMD ages based on birth year as listed earlier, taxes and 10% penalty for early unqualified withdrawals, and contributions limited to your earned income.
What Are the Different Types of IRAs?
Common ones are traditional and Roth; others include SEP for self-employed, SIMPLE for small businesses, and self-directed for alternative investments.
What Are the Disadvantages of Traditional IRAs?
Disadvantages include taxes and penalties on early withdrawals unless exempt, locking funds in for years, and taxes on growth at withdrawal.
Does a Traditional IRA Grow Tax-Free?
No, it grows tax-deferred, not tax-free; contributions are deductible, but withdrawals of growth are taxable, unlike Roth where growth is tax-free.
The Bottom Line
A traditional IRA is a popular way to save for retirement with pre-tax contributions that grow tax-deferred. You can't access it until 59½ without penalties, but it defers taxes on growth until then.
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