What Is a Traditional IRA?

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What Is a Traditional IRA?

The traditional individual retirement account (IRA) is a popular retirement plan for many investors. Besides helping build your retirement nest egg, the contributions you make may be tax-deductible.

The traditional vs. the Roth

In order to identify the traditional IRA, it may help if we distinguish it from the Roth IRA. The differences lie in deductibility and taxability. For the sake of clarity, remember that every IRA has two components: the contributions you make to it, and the potential earnings that grow in it.

The traditional IRA has these characteristics

• Contributions you make may be tax-deductible.
• If your contributions are deductible, you will be taxed on them when you make withdrawals (your contributions must be taxed at some point).
• Any dividends or capital gains that accumulate on your contributions will not be taxed until you make withdrawals and are taxed as part of your gross income in the year distributed.

The Roth IRA has these characteristics

• Contributions you make are never tax-deductible.
• You will not be taxed on your contributions when you withdraw them if you follow all the rules.
• Any dividends or capital gains achieved from your contributions will not be taxed at all if you begin making withdrawals after age 59½ and you have waited at least five years to do so.

Contribution limits

The largest contribution allowable to either plan for 2024 is the smaller of $7,000 or 100 percent of earned income from employment. Unmarried individuals must have earned income in order to contribute to IRAs. In many situations, spouses of income-earners who have little or no earned income of their own may rely on their spouse’s earned income to make an IRA contribution. One must not exceed the maximum contribution amount for all traditional and Roth IRA accounts combined. The law also allows taxpayers age 50 and above to make an extra, "catch-up" contribution of $1,000. So, in 2024, taxpayers have an $8,000 annual IRA contribution limit in the year that they turn 50. Due to changes in the law in 2019 and 2022, traditional IRA owners can continue contributing to their IRAs past the age for taking required minimum distributions, which is now 73.

The catchup contribution for those 50 and over will be indexed to inflation starting in 2024.

If you are currently in a high tax bracket but foresee being in a lower one after you retire, you can benefit greatly from a traditional IRA, because your withdrawals will be taxed at the rate that applies when you make the withdrawal.

Outside of specific exceptions provided by the IRS, distributions prior to age 59½ are subject to an additional 10% tax penalty.