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traditional ira

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 2019, it’s $6,000, 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.

Pros and Cons of Traditional IRAs

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 and exchange-traded funds (ETFs). You can deduct some or all of your contributions, up to the cap, from your income on your tax return.

Choosing a retirement plan is a personal decision, but here are some of the major pros and cons of using a traditional IRA:

Pros:

  • Tax-deferred contributions and gains
  • Investment choices completely up to the individual
  • Simple to declare on a tax return
  • No need to move accounts when changing employers

Cons:

  • Income tax due on both contributions and gains when in retirement
  • No company match like in some 401(k) plans
  • Relatively low annual contribution limit
  • 10% penalty for early withdrawals

Traditional IRA Limits and 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 $6,000 for 2019. You can deposit up to $7,000 if you are age 50 or older.

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. Anyone who is single and not covered by a workplace retirement plan can take the full deduction. Individuals covered by a workplace retirement plan earning $64,000 or less per year also are eligible for the full deduction up to the contribution limit. Individuals who make between $64,000 and $74,000 are eligible for a partial deduction. Those who are single and earn $74,000 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 $193,000 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 $103,000 or less.

You’re able to start making withdrawals from your IRA once you’re 59.5. Any withdrawals taken before then are generally penalized 10%. 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 70.5, you must start taking required minimum distributions (RMDs) from your traditional IRA.

Traditional IRAs and Your Tax Return

traditional ira

Eligible contributions to a traditional IRA are tax-deductible. This means you can claim up to $6,000 (or $7,000 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 be taxed as income, rather than as capital gains. (Capital gains are taxed at 0% of up to $78,750 for married joint filers in 2019). 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.

Investing with a Traditional IRA

traditional ira

When you open a traditional IRA, you’ll put money into your account and choose your 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 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 market gains.

The 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.

A traditional IRA is tax-deferred, meaning 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

  • Once you open your traditional IRA, you may want to get further guidance from a financial advisor. SmartAsset can help you find one with our free financial advisor matching service. You answer a few questions about your finances. Then, we match you with up to three financial advisors in your area, all free of disclosures and fully vetted. You make a decision about how to proceed after speaking with each of your matches.
  • Use SmartAsset’s retirement calculator to figure out how much retirement income you’ll need. This can help you figure out if you’re on track.

Photo credit: © iStock/cnythzl, © iStock/Kameleon007, © iStock/dlerick

Ben Geier, CEPF® Ben Geier is an experienced financial writer currently serving as a retirement and investing expert at SmartAsset. His work has appeared on Fortune, Mic.com and CNNMoney. Ben is a graduate of Northwestern University and a part-time student at the City University of New York Graduate Center. He is a member of the Society for Advancing Business Editing and Writing and a Certified Educator in Personal Finance (CEPF®). When he isn’t helping people understand their finances, Ben likes watching hockey, listening to music and experimenting in the kitchen. Originally from Alexandria, VA, he now lives in Brooklyn with his wife.
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