What is a traditional IRA?
A traditional IRA is like a special savings account for your retirement that you set up on your own, outside of your job’s retirement plan. Sometimes, when you put money into this account, you can lower the amount of taxes you have to pay. However, how much you can lower your taxes depends on how much you earn and how you file your taxes.
Once you’ve put your money into a traditional IRA, you can invest it without worrying about paying taxes on the gains right away. You only pay taxes when you take the money out, which is usually when you retire. So, while you’re working, the money in your traditional IRA can grow and make more money without the government taking a cut every year.
In simple terms, traditional IRAs give you an extra way to save for your retirement, and they can also help you pay less in taxes if you plan things right. If you’re ready to invest for the long haul and let your money grow over time, a traditional IRA can turn into a pretty big pile of money, all while keeping the taxman at bay.
What rules apply to traditional IRAs?
Age-related Contribution Rules: You can add money to a traditional IRA no matter how old you are, but there’s a catch. You have to be making at least as much money as you’re putting into the IRA. Before 2020, once you hit age 70 and a half, you couldn’t add any more money.
Contribution Limits: In 2022, the most you can put into an IRA, whether it’s traditional or Roth, is $6,000. But in 2023, that limit goes up to $6,500. Depending on how much money you make and how you file your taxes, you might get a tax break for the full $6,000.
Catch-Up Contribution: If you’re 50 years old or older, you get a bonus. For both 2022 and 2023, you can add an extra $1,000 to your IRA, making it a total of $7,000 in 2022 or $7,500 in 2023. This special extra contribution is called a “catch-up contribution.
Withdrawing Your Money: You can take money out of your traditional IRA without any penalties once you hit 59 and a half. But if you try to take it out before that and you don’t have a good reason, like a medical emergency, you’ll not only pay regular income taxes on what you take out, but you’ll also get hit with a 10% early withdrawal penalty.
When you reach 73 years old, you must start taking out a certain amount of money from your IRA every year. These are called Required Minimum Distributions (RMDs). It’s basically the government’s way of making sure they get their share of taxes eventually. The amount you have to take out is based on how long the IRS thinks you’ll live. Whatever you take out as RMDs gets taxed like your regular income, so it’s important to plan for this in advance.
Tax Deductions: Your ability to claim a tax deduction for your traditional IRA contribution depends on three main factors: how much you earn, your tax filing status, and whether you have a retirement plan through your job, like a 401(k).
If you are a single taxpayer who has a retirement plan through your employer:
| 2022 MODIFIED AGI* | 2023 MODIFIED AGI | MAXIMUM TAX DEDUCTION |
| $68,000 or less | $73,000 or less | $6,000 ($7,000 for ages 50 and up) in 2022; $6,500 ($7,500 for ages 50 and up) in 2023 |
| Between $68,000 and $78,000 | Between $73,000 and $83,000 | A reduced amount |
| More than $78,000 | More than $83,000 | None |
If you are a married couple filing your taxes jointly and you both have a retirement plan through your employer:
| 2022 MODIFIED AGI | 2023 MODIFIED AGI | MAXIMUM TAX DEDUCTION |
|---|---|---|
| $109,000 or less | $116,000 or less | $6,000 ($7,000 for ages 50 and up) in 2022; $6,500 ($7,500 for ages 50 and up) in 2023 |
| Between $109,000 and $129,000 | Between $116,000 and $136,000 | A reduced amount |
| More than $129,000 | More than $136,000 | None |
If you are an individual taxpayer who does not have a retirement plan through your employer:
| 2022 MODIFIED AGI | 2023 MODIFIED AGI | MAXIMUM TAX DEDUCTION |
| Any | Any | $6,000 ($7,000 for ages 50 and up) in 2022; $6,500 ($7,500 for ages 50 and up) in 2023 |
For married couples filing jointly, if neither of you has a retirement plan through your employer, and your spouse is also not covered by one:
| 2022 MODIFIED AGI | 2023 MODIFIED AGI | MAXIMUM TAX DEDUCTION |
| Any | Any | $6,000 ($7,000 for ages 50 and up) in 2022; $6,500 ($7,500 for ages 50 and up) in 2023 |
For married couples filing jointly, if you are not covered by a retirement plan at work, but your spouse is covered by one:
| 2022 MODIFIED AGI | 2023 MODIFIED AGI | MAXIMUM TAX DEDUCTION |
|---|---|---|
| $204,000 or less | $218,000 or less | $6,000 ($7,000 for ages 50 and up) in 2022; $6,500 ($7,500 for ages 50 and up) in 2023 |
| Between $204,000 and $214,000 | Between $218,000 and $228,000 | A reduced amount |
| More than $214,000 | More than $228,000 | None |
Can you transfer a traditional IRA?
In simple terms, you can move your traditional IRA to a different place or combine it with another one. When you do this, it’s super important to make sure that the tax rules of the new account match the old one.
Here’s an example: If you want to shift your traditional IRA to another traditional IRA at a different place, it usually won’t trigger any taxes. But, if you decide to move your traditional IRA to a Roth IRA, that money you move will be considered as taxable income (this is called a Roth conversion). So, it’s really important to understand the possible tax consequences before you go ahead with this kind of transfer.
What are the beneficiary distribution options?
When someone with a traditional IRA passes away, what happens next depends on who they named as the recipient. It’s important to remember that a traditional IRA is made up of money that hasn’t been taxed yet, so there are taxes that need to be taken care of eventually, even if it happens over time.
If the person who had the traditional IRA was your spouse, you have a choice. You can combine that money with your own traditional IRA, and you won’t have to pay any taxes right away. But if the IRA goes to someone who isn’t their spouse, like a child or a friend, it’s treated as an “inherited IRA.” In this case, the rules changed in 2020. The money generally needs to be withdrawn over a 10-year period. This is all because of the SECURE Act of 2019, which put these new rules in place.
Is a 401(k) a traditional IRA?
No, a 401(k) is not the same thing as a traditional IRA. A 401(k) is a retirement plan that your employer often provides as a work perk. While they have some similarities with traditional IRAs, they are completely separate accounts with their own set of rules.
A traditional IRA is something you set up by yourself, completely independent of your job. The rules for these accounts can vary depending on your personal situation. So, they might seem similar in some ways, but they’re not the same thing.
Is a rollover IRA a traditional IRA?
A rollover IRA is like a personal savings account for retirement. It’s created when you move money from a retirement plan you had through your job, like a 401(k), into your own account.
This rollover IRA can fall into the category of either a traditional IRA or a Roth IRA. On the flip side, a traditional IRA can also be called a rollover IRA, but it doesn’t have to be. It depends on where the money originally came from.
What Are the Downsides of Traditional IRAs?
Just like with other ways of saving for retirement, taking money out of a Traditional IRA before the right time can lead to taxes and penalties. This means Traditional IRAs aren’t very flexible when it comes to accessing your money. Also, the earnings you make in a Traditional IRA aren’t tax-free; when you take them out during retirement, you’ll have to pay taxes on them.
Where can I find the best traditional IRA?
Plenty of the online discount brokerage firms, like Fidelity, Vanguard, and Charles Schwab, are good choices when you want to start a traditional IRA. You can also visit The Motley Fool’s traditional IRA page to help you figure out which option suits you best.
