What Is a Traditional IRA and Who Should Have One?

A Traditional IRA Can be a Useful Retirement Saving Tool

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You may be saving for retirement in your employer's 401(k) or a similar qualified plan, but there's more you can do to grow your nest egg.

A traditional IRA (individual retirement account) is an account that offers a tax-advantaged way to save for retirement in addition to, or in place of, an employer-sponsored retirement account. 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.

But is a traditional IRA right for your retirement savings strategy? Here's how to decide. 

The Pre-Tax Advantage of Traditional IRAs

The primary benefit 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 the IRA, you can deduct that amount from your taxable income. This results in paying less income tax for the year.

For 2019, the maximum contribution to a traditional IRA is $6,000 and $7,000 if you're age 50 or older. The catch-up contribution allowed to older savers is a way to gain ground in your retirement saving efforts if you're concerned about falling short of your goal.

In addition to receiving a valuable tax deduction up front, 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 Instead, they're deferred until money is withdrawn from the IRA in retirement.

At this stage, it's taxed at your ordinary income tax rate. If you expect to be in a lower tax bracket when you retire, that means you'll owe less in taxes on your qualified IRA withdrawals

Who Can Contribute to a Traditional IRA?

Anyone with earned income is eligible to open a traditional IRA, but there are some restrictions as to who can deduct the contributions. There are income limits that are used to determine how much of the contributions are deductible, if any at all.

If you're currently covered by a retirement plan at work in 2019, you can deduct your full traditional IRA contribution if:

  • You're single or file head of household and your modified adjusted gross income is $64,000 or less
  • You're married and filing a joint return with an MAGI of $103,000 or less

Once you reach these limits, the deduction begins to phase out, reducing the amount of contributions you can deduct. If you're not covered by a retirement plan at work and you file single, you can deduct your full contribution, regardless of your income. If you're not covered by a plan at work but your spouse is, the full deduction is only available if your combined MAGI is $193,000 or less. A partial deduction is allowed if you're married and file separately and your MAGI is less than $10,000.

Taking Required Minimum Distributions From a Traditional IRA

One of the potential disadvantages of a traditional IRA is the forced distribution that must begin at age 70 ½. At this age, you have to begin taking minimum distributions, based on your life expectancy. Even if you don’t need the money, if you don't take at least the required minimum distribution (RMD) each year, you'll face a 50 percent penalty of the RMD amount.

On the flip side, withdrawals made prior to turning age 59 ½ are subject to a 10 percent early withdrawal penalty. There are some exceptions for avoiding the penalty. For example, you won't pay the penalty when you withdraw $10,000 of traditional IRA funds to buy a first home. You would, however, still owe regular income tax on the withdrawal. 

Is a Traditional IRA Right for You?

If your employer doesn’t offer a retirement plan, or you're looking for a way to save even more for retirement after maxing out your 401(k), then a traditional IRA could be a great option for saving pre-tax money for retirement. Keep in mind that depending on whether or not you’re married and if your spouse is covered by a retirement plan at work, you may be subject to income limitations, however.

A Roth IRA is also something to consider. With a Roth, you don't get a deduction for contributions but you can make qualified withdrawals in retirement 100 percent tax-free. That could be a huge plus if you anticipate being in a higher tax bracket once you retire. And, you don't have to take required minimum distributions from a Roth IRA at age 70 1/2. That allows your money to continue growing until you actually need to use it and you can continue making new contributions as long as you have earned income for the year.

Weighing the benefits of both traditional and Roth IRAs can help you decide which one makes the most sense as part of your retirement savings plan.