With a traditional individual retirement account (IRA), you contribute tax-deductible dollars to an investment account, where they grow tax-deferred. How much you can contribute per tax year is set by Congress. For 2024, it’s $7,000, plus a catch-up $1,000 for people 50 and older. There are other rules about how much is tax-deductible if your employer offers a 401(k) plan, when you can start making penalty-free withdrawals and more. Though fairly straightforward, you’ll want to be fully educated on traditional IRAs before you decide to use one to save for your retirement. A financial advisor can also help you build a retirement plan for your future.
What Is a Traditional IRA?
A traditional IRA is one of several types of IRAs. It is a tax-advantaged retirement account that allows individuals to put off paying taxes on their contributions and gains until they retire and start making withdrawals. These contributions are invested across various types of investments, most commonly mutual funds, exchange-traded funds (ETFs) and target-date funds. You can deduct some or all of your contributions, up to a cap, from your income on your tax return.
Choosing a retirement plan is a personal decision, as each have features that are best for certain people. Here are some of the major pros and cons of using a traditional IRA to help you make a decision:
Pros:
- Tax-deferred contributions and investment gains
- Investment choices completely up to the individual, though there are limits on alternative investments
- Simple to declare on a tax return
- Deducting your contributions now helps your current taxes
- No need to move accounts when changing employers
Cons:
- Income taxes due on both contributions and gains when in retirement
- No company match like in some 401(k) plans
- Relatively low annual contribution limits
- 10% penalty for early withdrawals (applies to all retirement accounts)
When you open a traditional IRA, you’ll put money into your account and choose investments. Mutual funds and ETFs are some of the most popular investments for traditional IRA users. These let you put your money into a fund with other investors, which a professional money manager then invests across multiple asset classes.
You can choose to be more aggressive by investing in actively managed funds. These are funds in which managers pick and choose stocks that they believe will beat the market and produce better returns for investors. Or you can choose passively managed funds, which track a stock index and essentially look to match general market gains.
Traditional IRA Contribution Limits and Tax Rules
Anyone with income (or married to someone with income) can open and contribute to a traditional IRA. However, there are limits to how much you can save in a traditional IRA each year. The maximum you can contribute to a traditional IRA is $7,000 for 2024. You can deposit an extra $1,000 (up to $8,000) if you are 50 or older, though.
While you’re always able to contribute the full amount, you may not be able to fully deduct your contributions, depending on your income level, relationship status and whether you or your spouse has a workplace retirement plan.
For 2024, anyone who’s single and not covered by a workplace retirement plan can take the full deduction. Individuals covered by a workplace retirement plan earning $77,000 or less per year also are eligible for the full deduction up to the contribution limit. Individuals who make between $77,000 and $87,000 are eligible for a partial deduction. Those who are single and earn $87,000 or more a year are not eligible for any deduction.
If you’re a married couple filing jointly and your spouse is covered by a workplace retirement plan, then you are eligible for a full deduction if your total income is $230,000 or less. If you’re a married couple filing jointly and you’re the one covered by a workplace plan, you’re eligible for a full deduction if you earn $123,000 or less.
You’re able to start making withdrawals from your IRA once you’re 59.5. Any withdrawals you take before then receive a 10% penalty. Exceptions to this include using up to $10,000 for a first-time home purchase or using the withdrawal to pay for medical costs. At age 73, you must start taking required minimum distributions (RMDs) from your traditional IRA.
Deducting Your Traditional IRA Contributions on Your Tax Return
Eligible contributions to a traditional IRA are tax-deductible. This means you can claim up to $7,000 (or $8,000 if you are 50 or older) as a deduction from your income when you file your tax return. A tax preparation software like TurboTax, which will collect all of your information and make the relevant deductions for you, makes this easy.
When you make withdrawals in retirement, the government taxes it as income. Some states don’t tax IRA withdrawals, but the federal income tax always applies. This is an advantage for many people because they are likely to be in a lower tax bracket in retirement than they are while working. Thus, their contributions are likely to be subject to a lower tax rate.
That said, your gains will also come under income taxes, rather than as capital gains. So depending on your tax bracket and filing status in retirement, you could end up paying more taxes on the gains than if you had not invested through a tax-deferred account. For many people, in fact, a Roth IRA is a better deal, as you pay taxes upfront on the contributions – but owe none on your gains.
How to Open a Traditional IRA
If you decide that a traditional IRA is right for you, it’s time to open an account. This is a fairly simple process. However, you’ll want to make sure you have all your relevant financial information ready when you start the process. You’ll need your bank account information and Social Security number, at the very least.
You’ll also need to pick a provider. Some banks offer IRAs, as do many mutual fund companies. Once you’ve chosen the company you want to use, go to its website and follow the instructions for opening an account. You’ll connect your bank account to your new traditional IRA and deposits will come directly from there.
Bottom Line
A traditional IRA is an option for anyone who wants to save for retirement and doesn’t have access to a workplace plan. You can also open a traditional IRA alongside your workplace retirement account to maximize your retirement savings.
Again, a traditional IRA is tax-deferred. This means you deduct it from your taxable income now and pay taxes later on your retirement distributions. There are a number of investment options available within a traditional IRA, so you can choose the investments that make the most sense for you.
Retirement Tips
- Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- SmartAsset’s retirement calculator can help you get a sense of if you’re on track to meet your goals.
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