What is a traditional IRA?

A traditional Individual Retirement Account (IRA) is a tax-advantaged retirement savings account in the United States. It allows individuals to contribute money to their retirement savings and provides certain tax benefits. Here's how a traditional IRA works:

1. Eligibility:

   • To contribute to a traditional IRA, you must have earned income. There is no maximum age limit for contributions, unlike some other retirement accounts. However, there is a minimum age requirement for making penalty-free withdrawals.

2. Contributions:

   • You can contribute to a traditional IRA up to the annual contribution limit set by the Internal Revenue Service (IRS). As of 2023, the annual contribution limit is $6,000 for those under age 50 and $7,000 for those aged 50 and older (including catch-up contributions). Contributions are tax-deductible, meaning they can reduce your taxable income for the year in which you make the contribution.

3. Tax Deductibility:

   • The deductibility of traditional IRA contributions depends on your income and whether you (or your spouse, if married) are covered by a retirement plan at work. If you are not covered by a retirement plan at work, your contributions are fully tax-deductible regardless of your income. If you or your spouse are covered by a retirement plan at work, the deductibility may be limited or phased out based on your income.

4. Tax-Deferred Growth:

   • Once the money is in your traditional IRA, it can grow tax-deferred. This means you do not pay taxes on the earnings, interest, or capital gains generated by the investments within the account until you make withdrawals.

5. Withdrawals:

   • You can start making penalty-free withdrawals from your traditional IRA at age 59½. However, withdrawals taken before this age are generally subject to a 10% early withdrawal penalty, in addition to income taxes on the amount withdrawn.

6. Required Minimum Distributions (RMDs):

   • Traditional IRAs are subject to required minimum distributions (RMDs) starting at age 72 (prior to 2020, the age was 70½). RMDs require you to withdraw a minimum amount from your account each year to ensure the IRS collects taxes on the tax-deferred funds.

7. Taxation of Withdrawals:

   • When you make withdrawals from your traditional IRA in retirement, the amount withdrawn is subject to ordinary income tax. This means that you pay taxes on both the contributions and any earnings. Your tax rate in retirement can vary based on your income during that period.

8. Penalty-Free Early Withdrawals:

   • There are specific exceptions that allow for penalty-free early withdrawals, such as using the funds for higher education expenses, first-time home purchases, medical expenses, and certain other qualified expenses.

9. Inherited Traditional IRAs:

   • Traditional IRAs can be inherited by beneficiaries, who are subject to certain rules and distribution options based on their relationship to the original account owner.

10. Portability:

    • You can maintain your traditional IRA account even if you change jobs or stop earning income. This allows you to keep contributing and managing your retirement savings throughout your life.

A traditional IRA is a valuable tool for retirement planning, especially if you qualify for tax-deductible contributions. However, you should be aware of the rules and regulations surrounding traditional IRAs, including the income limits for deductibility and the rules for required minimum distributions. Consult with a financial advisor or tax professional to make the most of your traditional IRA and ensure that it aligns with your retirement goals.