We all dream of a comfortable retirement, and there are many strategies and tools to get us there. When it comes to financially preparing for the retirement stage of life, a Traditional IRA is one avenue within your portfolio to explore.
What is a Traditional IRA?
A Traditional individual retirement account (IRA) is a tax-deferred account that savers can establish specifically for retirement savings. As opposed to the well-known Roth IRA which provides after-tax contributions for tax-free income in retirement - a Traditional IRA offers the opportunity to save money for retirement without the upfront taxation. A self-directed Traditional IRA also allows you, the contributor, to invest in a variety of ways, including stocks, bonds, mutual funds, CDs and money markets, making it a highly customizable addition to your portfolio.
How does a Traditional IRA differ from a Roth IRA?
The main differentiator between a Traditional IRA and a Roth IRA all comes down to the way it’s taxed. Contributions to your Traditional IRA are taxed later in life when it’s time to collect the saved funds. When contributing to a Roth IRA, your contributions are taxed now, on the way to being saved. While both options offer benefits, it’s important to know the difference when planning out your portfolio.
Is a Traditional IRA better than a 401(k)?
Just like any other investment opportunity, it’s important to stay educated and up to date on what will work best for your individual goals and retirement plans. Each investor is unique in their vision for their golden years. When you know all of your options, you can make sensible decisions in partnership with your financial advisor and rest easy knowing your portfolio is personalized to your financial goals.
Can anyone set up a Traditional IRA account?
As long as you have taxable income, you are eligible to contribute to a Traditional IRA. As a bonus, additional contributions can be made for a non-working spouse if the couple is married, files a joint return and the working spouse has taxable compensation.
What are the benefits of saving to a Traditional IRA?
There are many advantages to establishing a Traditional IRA:
- Your Traditional IRA contributions may be deductible on your tax return, and generally, amounts are not taxed until they are distributed - making this a great way to help shield your income from taxes. In some cases, this can mean a tax credit or “savers credit” for contributors. Whether the contributions are deductible can be confirmed by reviewing the full details of Traditional IRA deductions.
- Since many retirees often fall into a lower tax bracket than they did in previous years, saving money now to your Traditional IRA can save those dollars for a time in your life when you will be taxed less. Traditional IRAs can be a smart way to save yourself from higher taxes now, and create more income for you later in life.
- Individuals can typically contribute to their Traditional IRAs for the previous year up until their tax deadline (around mid-April).
- In some cases, Traditional IRAs can be converted to Roth IRAs later if that is beneficial to your portfolio and your future plans.
What are the Traditional IRA contribution limits?
In 2023, an individual can contribute the lesser of 100% of taxable compensation, or a maximum of $6,500, to a Traditional IRA. If you are over the age of 50, an additional contribution of $1,000 is allowed as “catch up” totaling $7,500.
What are the tax implications of contributing to a Traditional IRA?
As explained earlier, Traditional IRAs are often beneficial when it comes to lowering your taxes. However, if you cannot deduct your contribution, you can still report it on IRS Form 8606 for each year a non-deductible contribution is made.
Can I deduct Traditional IRA contributions on my yearly tax return? And, if I can't, should I bother contributing?
If you or your spouse is an active participant in an employer sponsored retirement plan, the "Pension Plan" box will be marked on your annual W-2 form. An employer retirement plan is any of the following:
- Qualified pension, profit sharing, stock bonus, money purchase pension plan, etc.
- SEP IRA, or SIMPLE IRA plan
- Plan established by the United States, state or political subdivision (other than a 457(b) plan)
- Union plan, Qualified Annuity Plan, or 501(c)(18) trust
If you can’t deduct your contributions to your Traditional IRA from your yearly tax return, it could still be a smart idea to invest. Later down the road, you may appreciate adding the contributions now to your Traditional IRA, as your tax bracket could be lower when you retire than what it was when you were working. Retirees often rely on a fixed income, and every dollar saved can really add up.
Are particular earners better suited for a Traditional IRA?
Everyone can benefit from contributing to a Traditional IRA, with tax savings corresponding to the amount contributed.
Is there a penalty for withdrawing from your Traditional IRA early?
Real life happens, and sometimes funds are needed for emergencies or unexpected costs. Often with age, health concerns arise and can sometimes be costly. If you are younger than 59 ½ years of age and withdraw from your Traditional IRA account, you may be subject to a 10% IRS penalty in addition to income taxes on the funds. The good news is, if you are using these funds for college tuition, a first-time home purchase, or expenses for medical purposes, death, disability or health insurance due to a period of unemployment, you might not be charged the withdrawal penalty.
*Withdrawals are subject to IRS rules and regulations. Please see your qualified tax professional for all the relevant information before making a decision.
Edward Jones, its employees and financial advisors cannot provide tax or legal advice. You should consult your attorney or qualified tax advisor regarding your situation.