Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It may not have not been reviewed, commissioned or otherwise endorsed by any of our network partners or the Investment company.
Updated on Wednesday, December 9, 2020
Whether you have a Traditional IRA by itself or alongside your employer-sponsored 401(k), we cover the rules that govern these types of accounts in 2021.
Before you learn about the new rules, make sure you understand what a Traditional IRA is and how these changes can impact your retirement savings.
What is a Traditional IRA?
An IRA is an investment account that you can set up to save money for retirement.
When you invest your money into an Individual Retirement Account (IRA), you have your choice between a few different account types. The most popular ones are Traditional and Roth IRAs.
The most significant differences between these two IRA types are the tax implications. Roth IRAs are taxed when you make contributions, while Traditional IRA contributions go in tax-deferred. There is no wrong choice for an IRA, but you should pick what works best for your financial situation.
Traditional IRA basics
Here’s how a Traditional IRA works:
- Your contributions to a Traditional IRA are tax-deductible the year you make contributions if you fall under the income limits for the deduction. It’s not until you withdraw money from a Traditional IRA that you are taxed. These withdrawals are then taxed as ordinary income.
- You can make contributions until you’re 70 and a half years old, but you must also start taking minimum distributions at that age.
- Traditional IRAs don’t have income restrictions for contributions like Roth IRAs do.
Traditional IRA contribution rules
- The maximum amount you can contribute in 2021 is $6,000.
- If you’re 50 or older, you can contribute an extra $1,000 making your max contribution $7,000. This is considered a “catch-up” contribution, allowing you to save as much as possible before you reach retirement age.
- If you’re contributing to a retirement plan through your job, like a 401(k), you can also contribute to a Traditional IRA.
- If you make rollover contributions to an IRA, those contributions are exempt from the contribution limit rules.
You can contribute to both a Traditional and a Roth IRA in the same year, but your contributions can’t exceed these limits across the accounts.
Traditional IRA tax deduction rules
The 2021 deduction rules are based on your filing status and adjusted gross income (AGI). How much you earn impacts directly how much of your Traditional IRA contributions you can deduct from your federal and state income taxes.
If you have an employer-sponsored retirement plan:
To qualify for a full deduction up to the amount of your contribution limit, you need to earn $66,000 or less if you’re filing independently. If you’re married or filing jointly, you’ll need to earn $15,000 or less.
The allowable deductions are phased out, starting at the income levels stated above. You can qualify for a partial deduction if you make between $66,000 and $76,000 as a single filer or between $105,000 and $125,000 if you’re filing jointly.
If you don’t have an employer-sponsored retirement plan:
You can qualify for a full deduction of the amount of your contribution limit no matter what your salary is whether you’re filing jointly or independently. Keep in mind that if you file jointly, your partner can’t have a plan that’s covered by work.
If you don’t have a plan covered by work but your spouse does, your AGI will need to be below $198,000 to qualify for a full deduction.
Traditional IRA withdrawal rules
When it comes to taking money out of your Traditional IRA, age matters.
If you’re younger than 59 and a half: You can withdraw but your withdrawals are subject to a 10% tax penalty. Depending on your situation, though, you might be able to get an exemption.
Exemptions to the age rule include:
- First-time home purchase
- Qualified educational expenses
- Unreimbursed medical expenses
- Health insurance if you are unemployed
- Qualified military reservists called to active duty
If you’re 59 and a half or older: You can start taking money out of your Traditional IRA without getting hit with a penalty.
If you’re 70 and a half: With Traditional IRAs, you must start taking money out at this age. It’s also known as a required minimum distribution (RMD).
Deciding if a Traditional IRA is right for you
If you’re unsure if you should open a Traditional IRA, make sure you compare your options to other retirement plans.
The “Find a Financial Advisor” links contained in this article will direct you to webpages devoted to MagnifyMoney Advisor (“MMA”). After completing a brief questionnaire, you will be matched with certain financial advisers who participate in MMA’s referral program, which may or may not include the investment advisers discussed.