A traditional IRA is a retirement savings account you can contribute to alongside your 401(k). It has special tax benefits, but there are contribution limits that you’ll want to be mindful of.
This guide will walk you through everything you need to know about how a traditional IRA works.
What is a traditional IRA?
A traditional IRA is a tax-deferred retirement savings account. Investors contribute pre-tax income meaning they won’t pay taxes on their earnings until they begin making withdrawals in retirement.
Traditional IRA contributions may be tax-deductible depending on your income and filing status. This can make a traditional IRA a useful part of a tax strategy to lower your annual tax obligation.
How does a traditional IRA work?
A traditional IRA is a type of retirement savings account that allows anyone earning an income to save money for retirement using pre-tax dollars.
Once invested, your contribution can grow tax-free. You won’t pay taxes until you begin making withdrawals.
Contributions made to a traditional IRA are tax-deductible, meaning the amount you invest can be deducted from your income up to the contribution limit.
Contributions must be made by April 15 to count as a deduction on your tax bill. You can make a contribution by rolling over an existing retirement plan or making contributions out of pocket.
Your employer won’t automatically make contributions for you. Set up a recurring deposit to your account to ensure you’re saving enough for your goals.
Taxes are assessed at your ordinary income tax rate once you begin making withdrawals.
Anyone who makes a withdrawal before age 59 ½ will be assessed an additional 10% penalty.
Here’s an example of how a traditional IRA works. Steve is 35 and earns $45,000 a year. He opens an IRA to begin saving for retirement.
In 2024, Steve contributed $7,000. His income is below the IRS limit which means he can deduct his entire contribution. As a single-filer, Steve is in the 22% tax bracket.
By deducting his IRA contribution, Steve reduces his taxable income to $38,000 moving to a lower tax bracket. If he continues to make the maximum contribution each year, he’ll have more than half a million dollars saved up by the time he’s ready to retire.
Traditional IRA Income Limits
While a traditional IRA is a great way to save for retirement and reduce your taxable income, there are limits to how it can be used.
In 2024, the average annual contribution is $7,000. Individuals who are 50 years old or older can contribute an additional $1,000 as a catch-up contribution, bringing their total to $8,000.
Deductions are limited income and filing status:
| Filing Status | Income Limit | Deduction Limit |
|---|---|---|
| Single | < $77,000 | Full |
| Single | $77,000 to $87,000 | Partial |
| Single | $87,000+ | None |
| Married Filing Jointly | < $123,000 | Full |
| Married Filing Jointly | $123,000 to $143,000 | Partial |
| Married Filing Jointly | $240,000+ | None |
| Married Filing Jointly (with a spouse covered by an employer) | < $230,000 | Full |
| Married Filing Jointly (with a spouse covered by an employer) | $230,000 to $240,000 | Partial |
| Married Filing Jointly (with a spouse covered by an employer) | $240,000+ | None |
| Married Filing Separately | < $10,000 | Partial |
| Married Filing Separately | $10,000+ | None |
Depending on your income, you might not be able to fully benefit from IRA deductions. Even if you don’t qualify you can contribute to a traditional IRA to save for retirement and generate tax-deferred savings from your contributions.
How much can I contribute to my traditional IRA?
Traditional IRAs limit individuals to contributing $7,000 per year in 2024 or $8,000 if you are age 50 or older. If you’re within the income limit, your contribution is deductible and can reduce your taxable income.
The $7,000 contribution limit applies to all IRAs – not just a traditional IRA. That means if you max out your contribution to one type of IRA you may not be eligible to contribute to another one.
Let’s say Steve contributed $7,000 to his traditional IRA but wants to also contribute to a Roth IRA. According to IRS guidelines, Steve can’t do that because he’s already hit his contribution limit for the year.
It’s possible to contribute to both a Roth IRA and a traditional IRA at the same time, however, if you hit your contribution limit for the year, you’ll have to wait before you can make an additional contribution.
Pros & Cons of Traditional IRAs
A traditional IRA is a popular alternative to a 401(k) when it comes to saving for retirement. Here are a few things to consider before you open an account.
Pros
- No income limits. Anyone who has qualified earnings can contribute to a traditional IRA.
- Tax deduction. If you fall within IRS guidelines, you may be able to deduct your IRA contribution, reducing your overall income.
- Tax-deferred growth. IRA contributions use pre-tax dollars and grow tax-free until you begin making withdrawals.
- Penalty-free exceptions. First-time homebuyers can use up to $10,000 from a traditional IRA toward purchasing a home without incurring a penalty (although taxes still apply if you’re under age 59 ½).
Cons
- Early withdrawal penalty. Unless there’s a qualified exception, anyone who makes a withdrawal before age 59 ½ will pay a 10% early distribution penalty.
- Required minimum distributions. Beginning at age 73 you must begin withdrawing from your account according to IRS guidelines.
- Withdrawals are taxed. When you retire and begin making withdrawals, your withdrawals will be taxed as ordinary income which could be high depending on your tax bracket.
How do distributions work for traditional IRAs?
Distributions are considered ordinary income and can be made penalty-free beginning at age 59 ½.
You are required to begin taking minimum distributions in your early 70s depending on when you were born:
| Age RMD Begins | Qualification |
|---|---|
| 73 | Anyone who turned 72 on or after January 1, 2023 |
| 72 | Anyone who turned 70 ½ between January 1, 2020 and December 31, 2022 |
| 70 1/2 | Anyone who turned 70 ½ before December 31, 2019 |
Distributions begin on April 1, after you hit the age requirement. For example, if you turn 72 in November 2024, you’ll need to take your first distribution by April 1, 2025. After that distributions must be taken by December 31.
Distribution amounts will vary based on your expected lifespan. Refer to the IRS Uniform Lifetime Table to calculate the exact amount you’ll be expected to take.
Anyone who takes a distribution before age 59 ½ will be assessed a 10% penalty, plus income tax.
There are a few exceptions to this rule including:
- Buying your first home
- Disability
- Passing your IRA on to a loved one after you die
- Qualified medical expenses
- Education expenses
- Expenses related to adoption or childbirth
- Medical insurance after a job loss
- IRS levy
- Nondeductible contributions
- Active duty military service
Roth IRA vs. Traditional IRA
Roth IRAs are tax-advantaged accounts made using after-tax dollars. While Roth IRAs don’t offer the same tax deductions as traditional IRAs, these accounts come with their own unique benefits during retirement.
| Criteria | Roth IRA | Traditional IRA |
|---|---|---|
| Contribution Limit | $7,000 ($8,000 50 years or older) combined across all IRAs | $7,000 ($8,000 50 years or older) combined across all IRAs |
| Deduction | No deduction | Full or partial deductions under income limit |
| Tax Implications | Contributions are made with after-tax dollars and earnings can grow tax-free. Distributions taken during retirement are not taxed. | Contributions that are eligible for a deduction can reduce annual taxable income. Distributions taken during retirement are taxed as ordinary income. |
| Early Withdrawal | Contributions can be withdrawn without penalty but earnings withdrawn before age 59 ½ are subject to 10% penalty | Withdrawals made before age 59 ½ are subject to 10% penalty |
| Required Distributions | No RMDs | RMDs begin at age 72 or 73 depending on year of birth |
Traditional IRA vs. 401(k)
A 401(k) is typically offered by an employer as a way to save for retirement. A traditional IRA offers comparable savings benefits with the added flexibility of allowing investors to open an account directly and choose how their investments are allocated.
| Criteria | Traditional IRA | 401(k) |
|---|---|---|
| Contribution Limit | $7,000 ($8,000 50 years or older) combined across all IRAs | $23,000 ($30,500 for investors 50 years or older) |
| Deduction | Full or partial deductions under income limit | Contributions are made using pre-tax income and is not eligible for a deduction |
| Tax Implications | Contributions that are eligible for a deduction can reduce annual taxable income. Distributions taken during retirement are taxed as ordinary income. | Distributions taken during retirement are taxed as ordinary income |
| Early Withdrawal | Withdrawals made before age 59 ½ are subject to 10% penalty | Withdrawals made before age 59 ½ are subject to 10% penalty |
| Required Distributions | RMDs begin at age 72 or 73 depending on year of birth | RMDs begin at age 72 or 73 depending on year of birth |
SIMPLE IRA vs. Traditional IRA
For small businesses or self-employed workers, a SIMPLE IRA is a special type of IRA to help you save for retirement. It offers a higher contribution limit than a traditional IRA helping workers save more for retirement.
| Criteria | SIMPLE IRA | Traditional IRA |
|---|---|---|
| Contribution Limit | $16,000 ($19,500 for investors 50 years or older) | $7,000 ($8,000 50 years or older) combined across all IRAs |
| Deduction | No deductions are available | Full or partial deductions under income limit |
| Tax Implications | Earnings are tax-deferred and distributions are taxed as ordinary income in retirement | Contributions that are eligible for a deduction can reduce annual taxable income. Distributions taken during retirement are taxed as ordinary income. |
| Early Withdrawal | Withdrawals made before age 59 ½ are subject to 10% penalty. If a withdrawal is made within two years of opening an account, it is subject to an additional 25% penalty. | Withdrawals made before age 59 ½ are subject to 10% penalty |
| Required Distributions | RMDs begin at age 72 or 73 depending on year of birth | RMDs begin at age 72 or 73 depending on year of birth |
How to Open a Traditional IRA Account
Before you open a traditional IRA, figure out how you want to manage your account. Traditional firms allow you to manage your investments yourself or work with a trained professional for a fee.
More and more fintech platforms offer robo-investing that gives you access to expert advice for a fraction of the cost. Determine how involved you want to be in managing your portfolio before opening a traditional IRA.
When you’ve decided where you’d like to open an account, create an account online or by visiting a brick-and-mortar branch. You may be asked to provide your driver’s license and Social Security Number to verify your identity.
Once your account is open, you’ll need to fund it. Rollover funds from an existing retirement account or link an external bank account. Most brokerage firms and IRA custodians like Schwab, Fidelity, and Vanguard don’t have any minimum investing requirements.
After your account is opened, you can begin selecting assets to invest in. This includes stocks, bonds, mutual funds, and ETFs. Be sure to allocate your investments otherwise your contributions will just collect interest like a savings account.
Are traditional IRAs a good idea?
A traditional IRA is a type of retirement savings account that you can contribute to alongside an employer-sponsored 401(k).
An IRA gives you more control over how your money is invested, allowing you access to low-cost index funds or sector-specific ETFs.
If you’re not already maxing out your employer-sponsored 401(k) a traditional IRA can be a good way to increase your savings rate. Find a broker or investment platform that aligns with your goals and start saving.
The sooner you start, the more you’ll earn in the long run.
FAQs
Can I withdraw money from my traditional IRA?
Yes, you can withdraw money from a traditional IRA, but if you do so before the age of 59 ½ you will pay a 10% penalty in addition to income tax on the total withdrawal amount.
How to convert a traditional IRA to a Roth without paying taxes?
There isn’t a way to convert a traditional IRA to a Roth IRA without paying taxes but there is a way to access your retirement savings early while minimizing your tax hit.
Using a Roth Ladder Conversion, you can convert a portion of your traditional IRA over a period of time, paying taxes on the amount you convert. To avoid the 10% early withdrawal penalty, you’ll have to wait five years before accessing your funds.
When do you pay taxes with a traditional IRA?
You will pay taxes on a traditional IRA when you begin making withdrawals in retirement. Withdrawals are taxed as ordinary income and will be taxed according to your tax bracket when you begin making withdrawals.
What is better, a Roth IRA or Traditional IRA?
One type of IRA might be better than another based on how they are taxed. A traditional IRA is tax-deductible and you aren’t taxed until you make a withdrawal.
A Roth IRA uses after-tax dollars and offers no deductions but earnings grow tax-free and can be withdrawn tax-free in retirement.
