What Is a Traditional IRA?

Definition & Examples of a Traditional IRA

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A traditional IRA is an investment account that offers tax-advantaged retirement savings. Contributions to a traditional IRA are tax-deductible, though you must pay tax on withdrawals in retirement.

Learn how contributions, tax deductions, and withdrawals work for a traditional IRA and whether it's the right choice for you.

What Is a Traditional IRA?

A traditional IRA (individual retirement account) is an investment account that allows you to save for retirement in addition to, or in place of, an employer-sponsored retirement account. It is an account that you hold individually in your own name.

In most cases, contributions are made to a traditional IRA on a pre-tax basis. This means that when you deposit money into the IRA, you can deduct that amount from your taxable income. This results in paying less income tax for the year.

In addition to receiving a valuable tax deduction, the money in the account grows tax-deferred. Any interest or capital gains from the investments aren't taxed when the gains are realized, the way they would be with a taxable brokerage account. Instead, they're deferred until money is withdrawn from the IRA in retirement.

Withdrawals from a traditional IRA are taxed at your income tax rate at the time of the withdrawal.

If you expect to be in a lower tax bracket when you retire, you'll owe less in taxes on your qualified IRA withdrawals than you would if you paid tax on that income now. 

Alternate names: traditional individual retirement account, traditional individual retirement arrangement

How a Traditional IRA Works

Anyone with earned income is eligible to open a traditional IRA. Contributions for the year must be made by your tax filing deadline, usually April 15, not including filing extensions.

Before 2020, anyone over age 70 ½ was no longer eligible to contribute to a traditional IRA, even if you had earned income. This rule was eliminated on January 1, 2020.

You can open a traditional IRA through a brokerage, mutual fund company, or even at your local bank, and the money you contribute can be invested in stocks, bonds, mutual funds, CDs, and other investments. Different funds will have a different balance of investments, allowing you to choose an IRA that:

  • Has an appropriate mix of stocks and bonds based on how close you are to retirement
  • Has investments that align with your values

Many financial institutions will offer target-date retirement funds. These funds generally start out more aggressive and risky, giving you the potential to earn more when you are younger and have time to recover from potential setbacks. As you get closer to retirement, the balance of investments held in the account automatically becomes more conservative.

You can choose to contribute occasionally to your IRA or set up regular contributions that are added every month. Contributing every month allows you to take advantage of dollar-cost averaging, which accounts for fluctuations in the market over time.

For many savers, the amount that you contribute each year can be claimed as a deduction when you file your taxes for that year.

How Much Can I Contribute to a Traditional IRA?

For 2020, the maximum total contribution you can make to all your IRAs, including both traditional and Roth IRAs, is $6,000. If you are age 50 or older, you can contribute up to $7,000.

If your total income for the year was less than the maximum contribution limit, you cannot contribute more than your total income.

The contribution limit does not apply to rollover contributions.

The higher amount for older savers is known as a catch-up contribution for those closer to retirement age. This allows you to gain ground in your retirement saving efforts if you're concerned about falling short of your goal.

It is better to save more for retirement early and use compound interest to grow your savings than to rely on catch-up contributions to fund your retirement.

How Much Can I Deduct on My Taxes?

The amount you contribute to a traditional IRA is not always fully deductible. Restrictions on what you can deduct are based on income limits. Once you reach these limits, the deduction begins to phase out, reducing the amount you can deduct on your taxes.

You can deduct your full traditional IRA contribution if you are:

  • Filing singly or as head of household with a modified adjusted gross income is $65,000 or less
  • Married filing jointly with a MAGI of $104,000 or less
  • Filing singly or as head of household and not covered by a retirement plan at work
  • Married filing jointly and neither you nor your spouse are covered by a retirement plan at work

If you're not covered by a plan at work but your spouse is, you can take:

  • The full deduction if your combined MAGI is $196,000 or less
  • A partial deduction if your combined MAGI is more than $196,000 but less than $206,000
  • No deduction if your combined MAGI is more than $206,000

You can take a partial deduction if you are covered by a retirement plan at work and you are:

  • Married filing separately and your MAGI is less than $10,000
  • Filing singly or as head of household with a MAGI is more than $65,000 but less than $75,000
  • Married filing jointly with a MAGI that is more than $104,000 but less than $124,000

You cannot take any deduction for contributions to a traditional IRA if you are covered by a retirement plan at work and you are:

  • Filing singly or as head of household with a MAGI of $75,000 or more
  • Married filing jointly with a MAGI of $124,000 or more

Contributions to a traditional IRA also make you eligible for the Saver's Credit on your taxes if you are:

  • At least age 18
  • Not claimed as someone else's dependent
  • Not a full-time student

What Are the Penalties?

You can withdraw money from your individual IRA at any time. However, depending on when you do, you may be subject to penalties.

You can be penalized for:

Even if you don't yet need the money, you must begin taking distributions from a traditional IRA either:

  • By April 1 following the year you turn 72 (and by December 31 for subsequent years)
  • By April 1 following the year you turn or 70 ½ if you reach that age before January 1, 2020

At that point, if you don't take at least the RMD each year, you'll face a 50% penalty of the RMD amount.

Early withdrawals are those made prior to turning age 59 ½. These are subject to a 10% early withdrawal penalty. 

There are some exceptions for avoiding the penalty. You won't pay the penalty if:

  • You withdraw $10,000 to buy a first home.
  • The participant/owner of the plan has died.
  • The participant/owner of the plan is totally and permanently disabled.
  • You use the withdrawal to pay for qualified educational expenses.
  • You use the withdrawal to pay for qualified unreimbursed medical expenses.
  • You use the withdrawal to pay for health insurance premiums while you are unemployed.
  • You are a qualified military reservist called to active duty.

However, you will still owe regular income tax on the withdrawal.

Do I Need a Traditional IRA?

A traditional IRA is a good option for saving pre-tax money for retirement if:

However, if your income prevents you from deducting your contributions, you may be better off choosing an alternative investment strategy for your retirement.

Alternatives to a Traditional IRA

A Roth IRA is a popular alternative to a traditional IRA. This is also a tax-advantaged retirement account, but the tax benefits work a little differently.

  • There is no tax deduction for contributions.
  • Qualified withdrawals in retirement are 100% tax-free.

You could gain more tax advantages from a Roth IRA if you anticipate being in a higher tax bracket once you retire or if your current income level prevents you from deducting contributions to a traditional IRA.

Another benefit of a Roth is that you don't have to take required minimum distributions at age 72. This allows your money to continue growing until you actually need it. You can also continue making new contributions as long as you have earned income for the year.

Key Takeaways

  • A traditional IRA is an investment account that offers tax-advantaged retirement savings.
  • Contributions to a traditional IRA are tax-deductible, though you must pay tax on withdrawals in retirement.
  • Restrictions on what you can deduct are based on income limits.
  • You must pay penalties you fail to take distributions from your IRA starting at age 72 or if you take withdrawals from your account before age 59 ½ (with some exceptions).
  • A Roth IRA is an alternative to a traditional IRA.

Article Sources

  1. Internal Revenue Service. "Publication 590-A (2019), Contributions to Individual Retirement Arrangements (IRAs): What's New for 2020." Accessed June 26, 2020.

  2. Internal Revenue Service. "Topic No. 451 Individual Retirement Arrangements (IRAs)." Accessed June 26, 2020.

  3. Internal Revenue Service. "Retirement Topics - IRA Contribution Limits." Accessed June 26, 2020.

  4. Internal Revenue Service. "Traditional and Roth IRAs." Accessed June 26, 2020.

  5. Internal Revenue Service. "IRA Deduction Limits." Accessed June 26, 2020.

  6. Internal Revenue Service. "2020 IRA Contribution and Deduction Limits Effect of Modified AGI on Deductible Contributions if You are NOT Covered by a Retirement Plan at Work." Accessed June 26, 2020.

  7. Internal Revenue Service. "2020 IRA Contribution and Deduction Limits Effect of Modified AGI on Deductible Contributions If You ARE Covered by a Retirement Plan at Work." Accessed June 26, 2020.

  8. Internal Revenue Service. "Retirement Savings Contributions Credit (Saver’s Credit)." Accessed June 26, 2020.

  9. Internal Revenue Service. "Retirement Topics — Required Minimum Distributions (RMDs)." Accessed June 26, 2020.

  10. Internal Revenue Service. "Retirement Topics - Exceptions to Tax on Early Distributions." Accessed June 26, 2020.

  11. Internal Revenue Service. "Roth IRAs." Accessed June 26, 2020.