Investing

What Is a Traditional IRA? Tax-Deferred Retirement Savings

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Are you tired of delayed gratification being the theme of every personal finance article? If so, a traditional individual retirement account (IRA) just might be the thing for you.

A traditional IRA is a retirement account that potentially gives you an immediate tax break for contributing, which means you can save for the future and save money today. These IRAs are a great way to accelerate your retirement savings and are available to everyone, no matter how much you make.

What is a traditional IRA?

A traditional IRA is a tax-advantaged retirement account that you open on your own, outside of any retirement plan offered by your employer.

There are no income limits on traditional IRAs, so you can contribute as long as you have earned income that year. You also get tax-deferred investment growth, and you may be able to deduct your contributions from your taxable income.

How do traditional IRAs work?

These IRAs offer two big tax breaks that help you invest for retirement as efficiently as possible.

Tax-deductible contributions

You can often deduct traditional IRA contributions from your taxable income when you file your taxes. For example, if your annual income is $66,000 and you contribute $6,000 to your traditional IRA, your taxable income will decrease to $60,000.

Not everyone can take advantage of this deduction; you can learn about eligibility details below. And it’s worth noting that you’ll pay taxes on withdrawals during retirement since you get a deduction today.

Tax-deferred growth

Whether or not you can take advantage of the tax deduction, every dollar you contribute to an IRA grows tax-deferred. So, as long as your money is in your IRA, it grows tax-free. You’ll only pay taxes when you begin taking withdrawals during retirement. Then, you only pay taxes at your regular income tax rate.

Traditional IRA contribution limits in 2022

The most you can contribute to a traditional IRA in 2022 is $6,000, though you can’t contribute more than you earned during the year. If you are 50+, you can contribute up to $7,000 — the extra $1,000 is called a catch-up contribution.

Something to remember is there’s a combined contribution limit with traditional and Roth IRAs. So, for example, you can contribute to both in the same year and split contributions however you’d like. However, the total contributed to both account types can’t be more than $6,000 (or $7,000 if you are 50+).

Are traditional IRA contributions tax-deductible?

Yes, traditional IRA contributions are generally tax-deductible. But not everyone can take advantage of that deduction.

Deductibility rules have to do with your filing status and modified adjusted gross income (MAGI).

Your filing status is…Your MAGI is…You can take…
Single or
head of household
$68,000 or lessThe full deduction up to the amount of your contribution 
Single or
head of household
More than $68,000 but less than $78,000A partial deduction
Single or
head of household
$78,000 or moreNo deduction
Married filing jointly or qualifying widow(er)$109,000 or lessThe full deduction up to the amount of your contribution 
Married filing jointly or qualifying widow(er)More than $109,000 but less than $129,000A partial deduction
Married filing jointly or qualifying widow(er)$129,000 or moreNo deduction
Married filing separatelyLess than $10,000A partial deduction
Married filing separately $10,000 or moreNo deduction
Source: IRS

 

Traditional IRA withdrawal rules

The flip side of tax-deductible contributions and tax-deferred growth is that traditional IRA withdrawals are generally taxable income for the year in which you make the withdrawal.

There is also an additional 10% penalty that applies to early withdrawals made before age 59.5. There are some exceptions, which include:

  • Up to $10,000 for qualified first-time homebuyers
  • Rollover to another retirement plan
  • Unreimbursed medical expenses
  • Qualified education expenses

A note on IRA required minimum distributions (RMDs)

Once you reach age 72 (or age 70 ½ if your 70th birthday was on or before June 30, 2019), you are required to make annual withdrawals from your traditional IRA. These mandatory withdrawals are called required minimum distributions (RMDs).

Your annual RMD is calculated by dividing your account balance by the value from the IRS Uniform Life Table that corresponds with your age. If your spouse is 10 years younger than you and the sole beneficiary of your IRA, you need to use this table to calculate your RMDs instead.

You can withdraw more than your RMD in any given year, but you can’t withdraw less. And the entire amount you withdraw is included in your taxable income.

When should you use a traditional IRA?

While traditional IRAs are fantastic retirement accounts, they might not be the best option for every investor. In fact, there are times when a Roth IRA or your employer’s retirement plan might make better sense for you.

A traditional IRA might make sense for you if…

  • Your employer plan isn’t great. An IRA can offer a broader range of investment options and potentially lower fees.
  • You are in a high tax bracket. Deducting IRA contributions on your taxes can help decrease your annual tax liability.
  • You’ve already maxed out contributions to your employer’s plan. If your finances allow, a traditional IRA can be a great way to save even more money for retirement.

A traditional IRA might not make sense for you if…

  • Your employer plan is excellent. It may be simpler to contribute to and manage a single retirement account like a 401(k) rather than opening another.
  • You are in a low tax bracket. The tax deductions for traditional IRAs may not be as valuable — and you might be better off making Roth IRA contributions.
  • You don’t qualify for a deduction. While you can still make non-deductible traditional IRA contributions, you may have better options.

What’s next?

The sooner you start saving for retirement, the longer your money has to grow. To keep you on track for a retirement done right, here are some ideas for what you can do next: