What Is a Traditional IRA?

If you’re looking for a way to supplement your retirement income, why not consider an individual retirement account (IRA). There are a couple of different types of IRAs: traditional, Roth, SIMPLE, and SEP. A traditional IRA is an account that grants the owner tax advantages when saving for retirement. You may open an IRA at several financial institutions: banks, credit unions, financial brokerage firms, or mutual fund companies. The funds you invest can be represented as stocks, mutual funds, bonds, or other investments.

Breaking down a traditional ira

What Is a Traditional IRA? Basic Facts to Know

When it comes to a traditional IRA, there are a few things you should be aware of.

Pre-tax contribution

Traditional IRAs are funded by pre-tax income. When tax time comes around, the amount that you invested can be deducted from your taxable income.
As a result, you can expect to pay lower taxes than you would have without an IRA.

Tax-deferred growth

Another tax benefit of a traditional IRA is how interest and capital gains are taxed. Taxes are not levied on the assets at the time their value increases. You are taxed at your ordinary income tax rate when the money is withdrawn at retirement. This could be beneficial since most people earn less annual income when they retire than when they are working. It’s likely that you’ll pay less tax on IRA income at that time.

Traditional IRA contribution limits

There is a limit to how much you can contribute to your IRA. In 2018, people under 50 could contribute up to $5,500. Someone aged 50 and older could invest up to $6,500. In 2019, these values will be increased to $6,000 and $7,000, respectively.

Income deductions

The contributions that you make may be deducted for the same year. Whether you’re eligible for this depends on two things. The first is if you or your spouse has an employer retirement plan, like a 401K. The second is your annual income. If you aren’t eligible, you can still put money into your IRA account; it just will not be tax-deductible.

How the IRS treats your traditional IRA distributions

The IRS considers these distributions as ordinary income and will apply income tax to it.

Age restrictions

There are age limits to when you can start withdrawing money from your IRA. Despite retiring early, you cannot begin withdrawing income until age 59 1/2, except under particular. (These include qualified tertiary education, home purchase, and medical/health insurance costs; disabilities; and active military duty beyond 179 days.) Early distributions come with a 10% penalty.

You must begin taking required minimum distributions, or RMDs, in the year in which you turn 72. Failure to start doing this will result in a penalty reduction of 50% of the RMD.

You are allowed to make contributions to the account as long as you’re working (starting January 1, 2020).

Traditional IRA

Who is Eligible for a Traditional IRA?

Everyone who earns income can open a traditional IRA, but not everyone can take the IRA deduction. As mentioned earlier, your 401K (or other employer retirement plan) and your income affect if you can deduct your contributions. Depending on how much you make, this can be reduced to zero.

For example, a couple married filing jointly could claim the full contribution with up $189,000 in combined income in 2018. For this to occur, both spouses must be working, and both contribute to a retirement plan at work. After $189,000 the deduction is phased out; at $203,000, it is eliminated entirely.

The Traditional IRA Contribution Limits Table lists a more comprehensive breakdown of the income limits to claim full, partial and no deductions.

Traditional IRA Contribution Limits for 2018 and 2019 Tax Years

The table below lays out the limits for full and partial IRA deductions.
If your filing status isandYou can claim the full deduction for your taxes if you earnedYou can claim a partial deduction for your taxes if you earnedYou cannot take any deductions for your taxes if you earned
married filing jointlyyou have a retirement plan at work$101,000 or less (in 2018);
$103,000 or less (in 2019)
more than $101,000 but less than $121,000 (in 2018);
more than $103,000 but less than $123,000 (in 2019)
$121,000 or more (in 2018);
$123,000 or more (in 2019)
married filing jointlyboth spouses have a retirement plan at work$189,000 or less (in 2018);
$193,000 or less (in 2019)
more than $189,000 but less than $199,000 (in 2018);
more than $193,000 but less than $203,000 (in 2019)
$199,000 or more (in 2018);
$203,000 or more (in 2019)
single or head of household-$63,000 or less (in 2018);
$64,000 or less (in 2019)
more than $63,000 but less than $73,000 (in 2018);
more than $64,000 but less than $74,000 (in 2019)
$73,000 or more (in 2018);
$74,000 or more (in 2019)
married filing separatelyyou or your spouse have a retirement plan at workN/Aless than $10,000 (in 2018 and 2019)$10,000 or more (in 2018 and 2019)

How Much Does an IRA Make per Year?

You can potentially earn more money from an IRA if you start your contributions earlier. It is difficult to say precisely how much you can make due to market fluctuations. Starting contributions early allows you to use the time value of money, which utilizes compound interest.

Compound interest is good for your money, as it lets you earn interest upon interest. (For a visual demonstration of how it adds up, check out our compound interest calculator.)

Is a Traditional IRA Right for You?

Whether you should choose a traditional IRA or an alternative investment type (a 401K, a Roth IRA, etc.) depends on the strategy you’re using to save for your retirement.

Most significantly, you should factor in whether your tax rate increase or decrease at retirement. A definitive answer to this question will identify the investment that can result in the lowest tax obligation at retirement. If you expect to pay less tax in retirement, a traditional IRA may be the best choice. If your tax rate increases, you may want to consider a different option.

In general, saving for retirement is a long-term plan. Each investment vehicle comes with risk. Carefully consider each option: the benefits, the risk, and the terms and conditions before you make your selection.

Whichever investment you choose, you should start contributing and maximizing your contributions, as early as you can.

Roman Zelvenschi

I started a digital marketing agency Romanz Media Group Inc. 12 years ago. Running my own business quickly taught me the importance of cash flow. Making sales was not enough, I had to have money in the bank to pay the vendors, staff and personal bills.

During those early stages of the company I learned how to get creative with debt and to save on interest cost. I paid for everything I could with a credit card to both get more points and to extend the payment date by 25 days (credit card grace period). I then utilized a 0% balance transfer offers to rotate this debt.

I learned a lot during this process and made a lot of mistakes. My key lesson is that the most important part of being financially independent is how much I managed to save, rather than how much I earned. Staying disciplined with savings and tracking spending is not easy and I tried many different methods to stay on track.

FinancialFreedom.Guru is a side project where I and my staff are trying to share the practical knowledge on how to understand finances and to build wealth.

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3 years ago

Are there any arguments against early retirement?

3 years ago
Reply to  Matt

Instead of working towards early retirement work towards a life you don’t want to retire from.

David Jones
David Jones
3 years ago
Reply to  Matt

Being social and being a part of a team which is contributing to something. If you enjoy your job why not keep going or reduce hours, it’s all personal circumstance but retiring too early can backfire for you career, mental health or what you have saved up if not managed well.

John M.
John M.
3 years ago
Reply to  Matt

I think the biggest risk is working too hard now, sacrificing adventures. Buy then when retirement comes, not having the health to enjoy it.

3 years ago
Reply to  Matt

None. You have more time to work on projects you have a passion for.
I’d get bored out of my mind if I “retired”.

Tom M.
Tom M.
3 years ago
Reply to  Matt

People often act like this is a silly question, but it really isn’t. Lots of retirees suffer from boredom and lack of motivation, and many think of retirement as the goal itself, rather than the things that excite and motivate you that you’ll have the freedom to pursue once you retire!

3 years ago
Reply to  Matt

You’re potentially giving up on your dreams, mission, and fulfilling your potential.