What Is A Traditional IRA?

If you are starting to research ways to start planning for your retirement, you may have run across the option of opening a traditional IRA, or individual retirement account, and wondered what a traditional IRA is, and is it the best option for you and your retirement? A traditional IRA is a retirement account with which you can save pre-tax dollars for use during retirement. The funds in your traditional IRA account can be invested in things like stocks, bonds, mutual funds, or CDs. You can set up and make contributions to a traditional IRA if you (or, if you file a joint return, your spouse) received taxable compensation during the year, and you were not age 70 by the end of the year.

THE TRADITIONAL IRA PRETAX ADVANTAGE

The principal advantage of a traditional IRA is that in most cases the contributions are made on a pre-tax basis. This means that when you deposit money into your traditional IRA, you can deduct that amount from your taxable income which results in you paying less income tax for the year. In addition to receiving the tax deduction up front from your traditional IRA, the money in the traditional IRA account grows tax deferred. Any interest or gains from the traditional IRA investments are not taxed when the gains are realized. Instead, the gains from your traditional IRA are deferred until money is withdrawn from the IRA, at which point the money is taxed as ordinary income.

WHO IS ELIGIBLE FOR A TRADITIONAL IRA?

Anyone with earned income, who is under the age of 70 is eligible to open a traditional IRA. There are however some restrictions as to who is permitted to deduct contributions, and income limits which are used to determine how much of the contributions are deductible, if you or your spouse are participants in an employer plan.

WHAT ARE TRADITIONAL IRA DISTRIBUTION REQUIREMENTS?

One issue to consider when determining if opening a traditional IRA is the right move for you and your retirement is the distribution requirement for traditional IRA accounts. With a traditional IRA, you must begin accepting distributions at the age of 70 even if you don't need the money yet. If you don't take the minimum required deduction (RMD) from your traditional IRA account, then you will be subject to steep penalties. Additionally, any monies withdrawn from your traditional IRA prior to the age of 59 will also be penalized with an early withdrawal fee, as well as the taxable amounts due.

IS A TRADITIONAL IRA RIGHT FOR YOU?

If you are one of the growing numbers of people whose employer doesn't offer a retirement plan, then a traditional IRA account is generally a very good option for putting away pre-tax dollars towards your retirement. Keep in mind though that if you are married and you or your spouse contributes to an employer plan, there are different income limitations which will determine your eligibility to deduct the contributions. For most people in retirement, they find themselves in a lower tax bracket than when they were employed, which allows for a greater tax break on the contributions made to your traditional IRA during your working years. Later in life, when you are no longer working, or working much less, the money you withdraw from your traditional IRA will be taxed in a lower tax rate, which is the main reason so many find opening a traditional IRA one of the best options to start saving for their retirement.