Your Quick Guide To Traditional IRAs

The earlier you start saving for retirement, the better. But what type of retirement account should you use? In this beginner’s guide, we’ll explain a popular option: traditional IRAs.

What Is A Traditional IRA?

A traditional IRA is a type of retirement plan that provides potential tax benefits to people who are saving for retirement. Account holders fund them with primarily pretax money. Then once they reach retirement age, they can withdraw funds at the ordinary income tax rate.

How Does A Traditional IRA Work?

A traditional IRA lets you deduct contributions from your taxable income for the year in which you make them. In other words, it lets you invest for retirement with pretax dollars.

Meanwhile, funds in your traditional IRA can grow tax-deferred. A custodian such as a bank or broker typically holds and manages the account and offers various investment options from which you can choose: stocks, bonds, mutual funds and ETFs.

Keep in mind, however, that the Internal Revenue Service (IRS) sets annual IRA contribution limits. Additionally, there are penalties for withdrawing funds before you reach the age of 59.5 and required minimum distributions (RMDs) once you reach the age of 72.

Those with traditional IRAs mainly benefit from the tax deductions when putting money in. But if you expect to be in a lower tax bracket when you retire, you can also minimize your tax liability when taking money out, making a traditional IRA especially strategic.

What are the IRA contribution limits?

In 2024, the annual IRA contribution limit (for traditional and Roth IRAs) is $7,000, or $8,000 if you’re age 50 or older. Both limits are a $500 increase from 2023.

Who Is Eligible To Open A Traditional IRA?

Anyone who has earned taxable income can open a traditional IRA, regardless of age. This includes minors with summer jobs, for example. Nonworking spouses who file joint federal tax returns can also qualify to open a traditional IRA.

If you participate in an employer-sponsored retirement plan such as a 401(k) or pension program, you can still open a traditional IRA. However, you might be disqualified from taking the full deduction on your contributions depending on your modified adjusted gross income (MAGI).

Who Is Eligible For A Tax Deduction On Traditional IRA Contributions?

If neither you nor your spouse are covered by a retirement plan at work, you can generally claim the full deduction for traditional IRA contributions — regardless of your income or whether you itemize deductions on your tax return.

However, if you or your spouse are covered by a retirement plan at work and your income reaches above a certain threshold, you may be disqualified from taking the full deduction.

What Are The Traditional IRA Income Limits?

If you have access to a retirement plan at work, here are the traditional IRA income limits that may impact your deductions:

If you don’t have access to a retirement plan at work but your spouse does, here are the traditional IRA income limits that may impact your deductions:

Withdrawing From A Traditional IRA

Once you reach the age of 59.5, you can withdraw from your traditional IRA penalty-free, though your withdrawals will be considered regular income and taxed accordingly.

Any withdrawals before the age of 59.5 will be subject to a 10% penalty fee on top of the standard income tax.

Early Withdrawal Penalty Exemptions

Fortunately for some, the IRS makes some exceptions to the early withdrawal penalty. Among other things, they include covering:

• Birth or adoption expenses, up to $5,000 per child
• Losses from natural disasters, up to $22,000
• First-time home purchases, up to $10,000
• Personal of family emergencies, up to $1,000 per calendar year
• Qualified higher education expenses

How To Open A Traditional IRA

Opening a traditional IRA is relatively straightforward. You have two main options:

Use A Brokerage

You can open a traditional IRA account with an online brokerage that offers different investment options (typically stocks, bonds, mutual funds and ETFs). It can provide administrative support, but it’s up to you to choose where to invest your traditional IRA funds.

Try Robo-Advisors

A robo-advisor is a digital financial advisor powered by algorithms. It can select and manage your investments based on your financial goals, risk tolerance, and time horizon. By using one to open a traditional IRA, you can take a more passive approach to retirement investing.

Other Types Of IRAs

While a traditional IRA is the only IRA type that lets you make tax-deductible contributions without an employer, it’s not for everyone. Consider other types of IRAs:

Roth IRA

A Roth IRA requires you to contribute after-tax dollars. However, once you reach the age of 59.5, you can withdraw your principal and earnings tax-free. There are not any required minimum distributions (RMD). If you think you’ll be in a higher tax bracket when you retire, a Roth IRA may be the best option.

SIMPLE IRA

A Savings Incentive Match Plan for Employees (SIMPLE) IRA allows contributions from employees and employers. It’s designed for small businesses with 100 or fewer employees and is relatively easy to set up and maintain. 

SEP-IRA

A Simplified Employee Pension (SEP) IRA is designed for small business owners and self-employed individuals. Unlike SIMPLE IRAs, it doesn’t allow contributions from employees. However, it has higher contribution limits.

Spousal IRA

A spousal IRA is simply a traditional or Roth IRA for a spouse who doesn’t work. If the married couple files joint tax returns, they can create a spousal IRA for the non-working spouse to double their combined contribution limit. In 2024, their new combined limit would be $14,000 (or up to $16,000 if both are age 50 or older).

Self-Directed IRA

A self-directed IRA (SDIRA) is a variation of a traditional or Roth IRA. The main difference is that it can hold a wider array of investments, including real estate, precious metals, promissory notes, cryptocurrency, and other alternative assets.

However, SDIRAs are only available through specialized custodians that can’t offer financial advice. Consequently, they are best suited for experienced investors.

Pros And Cons Of Traditional IRAs

Now that you know some of your retirement plan options, here are the pros and cons of choosing a traditional IRA:

The Bottom Line On Traditional IRAs

Ultimately, traditional IRAs can be a great vehicle to save for retirement and take advantage of tax breaks along the way. Have multiple retirement accounts? Download the Rocket Money^SM app today to track all of your accounts in one place.