A traditional IRA (individual retirement account) allows individuals to direct pre-tax income toward investments that can grow tax-deferred. The IRS assesses no capital gains or dividend income taxes until the beneficiary makes a withdrawal. Individual taxpayers can contribute 100% of any earned compensation up to a specified maximum dollar amount.
Income thresholds may also apply. Contributions to a traditional IRA may be tax-deductible depending on the taxpayer's income, tax-filing status, and other factors. Retirement savers may open a traditional IRA through their broker (including online brokers or robo-advisors) or financial advisor.
Traditional IRAs (individual retirement accounts) allow individuals to contribute pre-tax dollars to a retirement account where investments grow tax-deferred until withdrawal during retirement.
Upon retirement, withdrawals are taxed at the IRA owner's current income tax rate. Capital gains or taxes on dividends are not assessed.
Contribution limits exist ($6,000 for both 2019 and 2020 for those under age 50; $7,000 for those 50 and older), and required minimum distributions (RMDs) must begin at age 65.
Traditional IRAs let individuals contribute pre-tax dollars to a retirement investment account, which can grow tax-deferred until retirement withdrawals occur (at age 59½ or later). Custodians, including commercial banks and retail brokers, hold traditional IRAs and place the invested funds into different investment vehicles according to the account holder’s instruction and based on the offerings available.
In most cases, contributions to traditional IRAs are tax-deductible. If someone contributes $6,000 to their IRA, for example, they can claim that amount as a deduction on their income tax return and the Internal Revenue Service (IRS) will not apply income tax to those earnings. However, when that individual withdraws money from the account during retirement, those withdrawals are taxed at their ordinary income tax rate.
The IRS restricts the amount that one may add to a traditional IRA each year, depending on age. The contribution limit for the 2020 and 2021 tax years is $6,000 for savers under 50 years of age. For people aged 50 and above, higher annual contribution limits apply via a catch-up contribution provision, allowing for an additional $1,000 (or a total of $7,000).
When you have both a traditional IRA and an employer-sponsored retirement plan, the IRS may limit the amount of your traditional IRA contributions that you can deduct from your taxes.
In 2021, for example, if a taxpayer participates in an employer-sponsored program, such as a 401(k) or pension program, that individual, filing as a single person, would only be eligible to take the full deduction on a traditional IRA if their modified adjusted gross income (MAGI) was $66,000 or less, or $105,000 or less if married filing jointly. With MAGIs of $76,000 for singles and $125,000 for married couples, the IRS allows no deductions. In between, there's a partial deduction.
IRA contributions must be made by the tax filing deadline (including any extensions). For example, you can make a contribution to your 2021 IRA through April 15, 2022—or later if you file for an extension.7 If you are above the limits, you can still contribute post-tax income to a traditional IRA and take advantage of its tax-free growth, but investigate other options, too.
When you receive distributions from a traditional IRA, the IRS treats the money as ordinary income and subjects it to income tax. Account-holders can take distributions as early as age 59½. Starting after age 72, account holders must take required minimum distributions (RMDs) from their traditional IRAs.
Funds removed before full retirement eligibility incur a 10% penalty (of the amount withdrawn) and taxes, at standard income tax rates. There are exceptions to these penalties for certain situations