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What is a Traditional IRA – Restrictions and Benefits

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A Traditional IRA is very much like a Roth IRA except for the tax treatment. The Traditional IRA’s key advantage is that it allows an individual to make annual tax-deductible contributions to one’s retirement fund, but unlike the Roth IRA, the traditional IRA does not allow for earnings to grow tax-free. Ultimately, it comes down your personal financial situation when determining which IRA account is better for you.

Let’s go into a bit more detail regarding the Traditional IRA:

Traditional IRA Eligibility

Here are the rules to be eligible to fully contribute to a Traditional IRA:

  • All United States taxpayers that are not active participants in an employer sponsored plan are eligible to make contributions to a Traditional IRA plan.
  • The maximum annual contribution is $5,000 per person. Married couples can contribute $10,000. If you are 50 or older you can contribute $6,000 per person annually due to a catch-up provision.
  • Your contributions are tax deductible up to 100%.

Traditional IRA’s are a great way to save money and get a tax deduction at the same time. If you invest $5,000 annually into a Traditional IRA, you can claim a $5,000 tax deduction. This tax deduction will lower your adjusted gross income which lowers your tax liability. You do not have to pay any taxes on your contributions until you withdraw funds or at the age of 70 ½.

Traditional IRA Benefits

Tax Deductions – All contributions are fully tax deductible as long as your employer doesn’t offer a qualified retirement plan. If you are covered by an employer’s plan, you may still be eligible to receive a tax deduction depending upon your filing status and if you fall within certain income thresholds. Single filers that participate in their company’s retirement plan and earn $56,000 or less are eligible for a full deduction. Married filers that are active participants in their company’s plan and earn $89,000 or less are also eligible for a full income tax deduction.

No Income Limits On Participation – Everyone is eligible to enroll in a Traditional IRA but not everyone is eligible to receive a tax deduction.

Lower Tax Liability – Contributions can grow tax deferred and withdrawals can be taken in later years to reduce your tax liability. Since income is often lower during retirement years, funds withdrawn may be subject to lower taxes.

Multiple Retirement Accounts – A Traditional IRA can be set up even if you have another retirement plan. Contributions may not be fully tax deductible if you have enough qualified retirement plan.

Bankruptcy Protection – Contributions are protected from creditors.

Inheritance – You can pass assets onto beneficiaries after death.

Inherited ira written on a piggy bank in a tableTraditional IRA Restrictions

Minimum Withdrawal Requirements – There are required minimum distributions unlike in a Roth IRA. Withdrawals must begin at age 70 ½. If you fail to withdraw your required minimum distribution, the amount not withdrawn is taxed by the government at 50%.

Limited Contribution Period – You cannot make any contributions to a Traditional IRA after age 70 ½.

Choosing the right retirement plan depends upon a number of factors including suitability, eligibility, and the plan’s ability to meet your financial needs. A Traditional IRA is a good plan for those looking to reduce their taxable income and save money for their golden years. What is your favorite retirement plan? Do you prefer a Roth IRA or a Traditional IRA?

(Photo credit: alancleaver_2000)

Mark Riddix
Mark Riddix is the founder and president of an independent investment advisory firm that provides personalized investing and asset management consulting. Mark has written financial columns for Baltimore and Washington, D.C. area newspapers and is the author of the book, "Your Financial Playbook."

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