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Traditional IRA

Build a nest egg with pre-tax dollars and enjoy tax-deferred earnings with a traditional IRA.

Last Updated: 6/30/2022
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What Is a Traditional IRA?

A traditional IRA is a type of retirement savings that allows you to contribute pre-tax dollars. You can invest the money in your account as stocks, bonds or mutual funds.

Investing in a traditional IRA offers several benefits, especially regarding tax. The amount you contribute can be tax-deductible, making your taxable income smaller. Simultaneously, it allows you to grow your money tax-deferred. However, distributions and withdrawals are taxed according to your tax bracket.

MoneyGeek’s guide delves deeper into the ins and outs of a traditional IRA, ranging from how to open one to what happens when you make a withdrawal. Having a clearer understanding of a traditional IRA and its function may help you decide whether it’ll work for you as you prepare for retirement.

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Understanding Traditional IRAs

It’s never too early to start saving up for retirement. Having a traditional IRA (individual retirement account) is one of the ways you can set yourself up for retirement successfully.

Unlike other retirement programs or pension plans, anyone can open a traditional IRA. The only qualification is income. Once you open an account, you can begin making contributions using pre-tax funds immediately since it doesn’t have a vesting period. The sooner you put money in your account, the sooner you can start investing it.

Your contributions are tax-deductible, which allows you to lower your taxable income. Also, whatever earnings you have from your investments are tax-deferred, meaning they won’t be subjected to income tax until you make a withdrawal or distribution.

Taxable Compensation

The primary requirement for opening an account is taxable compensation. Technically, if you’re not earning, you cannot have a traditional IRA. However, not all money you receive qualifies as taxable compensation. Some examples of taxable compensation are as follows:

  • Amounts received for providing service (wages, tips and bonuses)
  • Commissions
  • Income from being self-employed
  • Taxable alimony and separate maintenance payments
  • Nontaxable combat pay

However, if you earn from renting out property, interest or dividends, you cannot use these earnings for contributions.

Your annual taxable income also determines your maximum contribution. For example, if you earn $50,000 annually, you can put in as much as $6,000 or $7,000, depending on your age. However, if you only earned $4,500 in a year, then $4,500 is the maximum contribution you can make.

Modified Adjusted Gross Income (MAGI)

A MAGI helps you determine how much of your contributions are tax-deductible.

Your allowable deduction becomes smaller if you also have a retirement plan at work and your MAGI falls within these ranges:

  • Between $109K and $129K (for a qualifying widow, widower or a married couple filing a joint return).
  • Between $198K and $204K (for a married individual filing a joint return where only your spouse has a retirement plan at work)
  • Between $68K and $78K (for a head of household or a single individual)
  • Less than $10K (for a married individual filing a separate return)

Traditional IRA vs. Roth IRA

Traditional IRA and Roth IRA share similarities, such as the option to save for retirement and the requirement to have taxable income.

However, there are distinct differences between them. Although the contribution limits are the same, those to traditional IRAs are tax-deductible if you qualify. For Roth IRAs, contributions are never deductible since you use post-tax funds. When you’re 59 ½, each time you take money out of your traditional IRA, it’s considered an income and is subjected to tax. Withdrawals from Roth IRAs are tax-free if they qualify for distribution.

The best IRA for you depends on your financial situation. If you expect to be in a lower tax bracket by the time you start making withdrawals, a traditional IRA can work for you. If not, a Roth IRA may be a better option.

  • Question
    Traditional IRA
    Roth IRA
  • Is there an age limit for
    opening an IRA?

    You can open a traditional
    IRA at any age. Starting
    in 2020, you can continue
    contributing even if
    you’re past 70½.

    There is no age limit for
    opening a Roth IRA.

  • Is there a limit to how
    much I can contribute per
    year?

    In 2022, the maximum
    amounts you can contribute
    to a traditional IRA are
    as follows:

    • Equivalent to your total
      taxable income for the year
    • $6,000 (for those under 50)
    • $7,000 (for those 50 and
      older)

    The last two limits apply
    regardless of how much
    you earn.

    The limits for 2022
    contributions to a Roth
    IRA are as follows:

    • Equivalent to your total
      taxable income for the year
    • $6,000 (for those under 50)
    • $7,000 (for those 50 and
      older)

    However, your allowable
    contribution may become
    lower depending on your
    income, filing status,
    Modified AGI and whether or
    not you contribute to
    another IRA.

  • Can I deduct contributions
    to an IRA?

    Since you use pre-tax
    dollars for traditional IRA
    contributions, you may
    deduct these from your
    taxable income.

    However, how much you can
    deduct depends on several
    factors. These include your
    filing status, income,
    whether or not you have a
    retirement plan at work and
    if you receive benefits
    from the Social Security
    Administration.

    You use post-tax dollars
    for your Roth IRA
    contributions so none of
    these are deductible.

  • Do I have to file a form
    just because I contribute
    to an IRA?

    You only have to file a
    form if you make
    nondeductible contributions
    to your traditional IRA.

    You don’t have to file a
    form for your Roth IRA
    contributions.

Opening a Traditional IRA

Healthy financial planning isn’t just about maintaining a budget and spending within your means. It also includes exploring alternatives that may bring long-term benefits. A traditional IRA is an excellent example of this.

Unlike a 401(k) or other retirement plans, which your employer opens for you, you’ll have to open a traditional IRA on your own. That’s why it’s best to understand your options. MoneyGeek’s guide provides you with the necessary information to make effective financial decisions.

Opening a traditional IRA doesn’t need to be complicated. There are only five main steps involved. Our guide will cover them all, including determining whether or not you’re qualified to make contributions.

1

Make sure you’re eligible

This is the easy part because there is only one requirement for opening a traditional IRA — a source of taxable income. If you and your spouse receive taxable compensation, you may open separate accounts (you cannot participate in a single IRA). You can still open a traditional IRA even if your spouse is the only one earning, as long as you file a joint return.

There is no age limit to open a traditional IRA or make contributions. Beginning 2020, you can make contributions if 70 ½ or older as long as you earn income. You can also choose to open a traditional IRA even if you have another retirement plan.

2

Decide where to open your account

You can open a traditional IRA at different financial organizations, such as banks, credit unions, brokerage firms and mutual fund providers. You can even look into hiring a robo-advisor. The ideal institution depends on your preferences.

How much help do you want to manage your funds? Two popular options are having a robo-advisor or a broker. The former allows for a more hands-off approach — technology typically takes care of everything. All you need to do is check your dashboard. However, a brokerage may be better if you’re not too tech-savvy or prefer a full-service experience.

3

Accomplish the necessary paperwork

Like any other financial account, you’ll need to present documentation and provide information to open it. These include the following:

  • A government-issued credential, such as your passport or driver’s license
  • Your personal details, including your complete name, contact number, birthday and social security number
  • Your beneficiaries’ information
  • Your preferred contribution method

If you want to deposit funds through a bank transfer, you need to provide your bank details. You can also have money rolled over from another retirement account, such as a 401(k), but it will require you to fill out some forms.

4

Choose where your traditional IRA goes

One benefit of having a traditional IRA is you have several options regarding where you can invest your money. Here are some that you might consider:

  • Stocks require that you buy shares of publicly traded companies.
  • Bonds might be your best option if you prefer low-risk investments that generate a predictable income stream. These are debt securities, like an IOU.
  • Mutual funds are less risky because you aren’t putting your eggs in one basket. A company pools money from multiple investors and invests it in a range of companies across different industries. Fund managers also do a lot of legwork for you, such as researching and selecting securities.
  • Exchange-traded funds (ETFs) are similar to mutual funds but trade money on a national stock exchange.

Depending on your financial goals and your level of risk-averseness, your evaluation of these options can show you what works best for you.

5

Start your contribution

An automatic transfer from your bank account can be an effective way to ensure you make regular contributions to your traditional IRA. However, it’s not a requirement.

You can adjust the frequency and amount of your contribution depending on your comfort level. You don’t need to put something in the account every month, nor does it have to be the same amount each time.

However, you do need to keep the contribution limits in mind. For 2022, the maximum is $6,000 (or $7,000 if you’re 50 or older). If your annual taxable income is less than that, your contribution limit for the year will also adjust.

Traditional IRA Contributions & Deductibles

A significant benefit of having a traditional IRA is that your contributions are tax-deductible. You can subtract it from your total taxable income when filing your return. As a result, you’ll owe less in taxes.

There are instances that even if you contribute the maximum amount for the year, you won’t be able to deduct everything. Your modified adjusted gross income (MAGI), your filing status and whether or not you (or your spouse) are covered by a retirement plan at work affect your allowable deductible.

Knowing how to compute for your MAGI helps you see whether you can make a full deduction, a partial one or if it isn’t possible.

MoneyGeek’s guide elaborates on this further. The first table below tackles the situation wherein you have a retirement plan at work. The second table covers the scenario of your traditional IRA as your only retirement savings plan.

You can use these two tables as a guide, making it easier to determine how much of a deduction you can make, if any. It may even help you make the most of your deductibles and make better financial decisions.

Contribution & Deduction for Individuals With Retirement Plans at Work

Having a retirement plan at work is a good thing. One advantage is that your employer manages it, and you can roll the amount over to a new 401(k) or a different retirement account if and when you leave that employer. However, many deduction limits would apply based on your MAGI.

There are only three instances wherein you can deduct your entire contribution. Everything else would result in a partial or no deduction.

  • Filing Status
    Modified Adjusted Gross Income (MAGI)
    Deduction Amount
  • Single or head of
    household

    $68,000 or less

    A full deduction up to the
    amount of your
    contribution limit

  • Single or head of
    household

    More than $68,000 but less
    than $78,000

    A partial deduction

  • Single or head of
    household

    $78,000 or more

    No deduction

  • Married filing jointly or
    qualifying widow(er)

    $109,000 or less

    A full deduction up to the
    amount of your
    contribution limit

  • Married filing jointly or
    qualifying widow(er)

    More than $109,000 but
    less than $129,000

    A partial deduction

  • Married filing jointly or
    qualifying widow(er)

    $129,000 or more

    No deduction

  • Married filing separately

    Less than $10,000

    A partial deduction

  • Married filing separately

    $10,000 or more

    No deduction

Contribution & Deduction for Individuals Without IRA Plans at Work

You can make a full deduction if you and your spouse don't have a retirement plan at work, regardless of your MAGI. However, you’ll need to consider your MAGI when your spouse’s employer provides a company-sponsored retirement account.

It’s still possible to be in a situation where you can make a full deduction, but most scenarios have a different outcome. Fortunately, the MAGI limits are typically higher compared to if you have a retirement plan at work.

  • Filing Status
    Modified Adjusted Gross Income (MAGI)
    Deduction Amount
  • Single, head of household,
    or qualifying widow(er)

    Any amount

    A full deduction up to the
    amount of your
    contribution limit

  • Married filing jointly or
    separately with a spouse
    who is not covered by a
    plan at work

    Any amount

    A full deduction up to the
    amount of your
    contribution limit

  • Married filing jointly
    with a spouse who is
    covered by a plan at work

    $204,000 or less

    A full deduction up to the
    amount of your
    contribution limit

  • Married filing jointly
    with a spouse who is
    covered by a plan at work

    More than $204,000 but
    less than $214,000

    A partial deduction

  • Married filing jointly with
    a spouse who is covered by
    a plan at work

    $214,000 or more

    No deduction

  • Married filing separately
    with a spouse who is
    covered by a plan at work

    Less than $10,000

    A partial deduction

  • Married filing separately
    with a spouse who is
    covered by a plan at work

    $10,000 or more

    No deduction

Withdrawing Funds From Your Traditional IRA

The primary purpose of having a traditional IRA is to have a nest egg by your retirement age. You’re required to take annual distributions when you turn 72. Yes, these will be taxable.

You can’t avoid taxes when you take money from your account — that’s the payoff from letting your funds grow tax-deferred. However, making a withdrawal before turning 59 ½ means paying an additional 10% tax.

Fortunately, there are several ways to avoid this. Here are nine scenarios that serve as exemptions, excusing you from paying the penalty.

1

Purchasing, building or rebuilding your first home

The IRS considers you a first-time homebuyer if you haven’t owned a home (besides the one you have if you’re rebuilding) in the last two years. You can withdraw up to $10,000 from your account and put it towards buying a house, regardless if it's for you, your children or your grandchildren.

If your spouse also has a traditional IRA, they can withdraw the same amount from their account. However, timing is essential in this scenario. You need to use the distribution within 120 days of your withdrawal.

2

Paying for higher education expenses

You can use the funds from your account to fund qualified higher education expenses. These cover the tuition, miscellaneous fees, supplies, equipment and books you need to enroll. The student doesn’t necessarily have to be you — it can be anyone in your immediate family.

3

Welcoming a child (through birth or adoption)

You have a $5,000 limit per adoption or birth. You must take the distribution within one year of your child’s birth or the finalization of the adoption. For the latter, your adoptee must be younger than 18 or someone who can’t self-support due to their physical or mental state.

4

Covering unreimbursed medical expenses

You can use IRA funds to pay for unreimbursed medical expenses beyond 7.5% of your adjusted gross income.

For example, say you earn $120,000 annually. Then, 7.5% of that is $9,000. If you have unreimbursed medical expenses reaching $20,000, your IRA can cover $11,000.

5

Paying for health insurance

You can use your IRA money to pay for health insurance premiums if you lose your job. You are still exempt from the additional tax if you receive the distribution within 60 days of when you start working again.

6

Arranging for substantially equal periodic payments

You can arrange to make penalty-free regular withdrawals from your traditional IRA, which allows you to receive a specific amount for five years or until you turn 59 ½, whichever comes first.

If you decide to go in this direction, remember that you cannot stop it in the middle of the process. Otherwise, you will incur a penalty.

7

Having a permanent disability

Becoming physically or mentally disabled may prevent you from doing substantial gainful activities. In situations like these, you may use your IRA funds before turning 59 ½ without paying additional tax.

A physician must certify that your condition may lead to your passing or will last indefinitely (at least a prolonged period).

8

Inheriting an IRA

If you have an existing IRA account at your passing, your beneficiaries or estate will receive your assets without paying the additional 10% tax.

On the other hand, if your spouse passes and you inherit a traditional IRA, you will pay the penalty for any distribution you receive before you turn 59 ½ if you choose to treat it as your own.

9

Being called to active duty

Military members can receive distributions penalty-free but only when on active duty.

Withdrawal Examples

Several factors can affect your IRA withdrawal experience. Knowing whether you qualify for an exemption or if your distribution is qualified can help you determine whether or not you pay a penalty.

Here are three situations wherein different IRA owners made withdrawals from their funds. As you’ll notice, some encountered a 10% penalty, while others didn’t. You can compare their situations to see how circumstances affected their withdrawals.

  • This is an icon

    Example 1: A Traditional IRA Withdrawal After Turning 60

    Elizabeth opened her traditional IRA in her forties. She has been very consistent in her contributions, and now that she’s about to turn 60, she has $100,000 in her account.

    Elizabeth knows that she’ll need to take annual distributions when she turns 72 but decides that she wants to take some money out to visit her son and his family, who currently live in California.

    Elizabeth decides to withdraw $10,000 from her traditional IRA on her 60th birthday. That amount is now taxable, and she’ll have to pay the corresponding amount in tax based on her current tax bracket.

  • This is an icon

    Example 2: A Non-Qualified Distribution from a Traditional IRA

    John wasn’t very keen on his finances until he was near retirement age. Only after repeated requests from his daughter did he finally open an IRA. Although he was already 55, John thought it was better late than never.

    That was three years ago. John chose to retire early and now finds himself at home more often. He lives alone in the first home he and his wife bought when they married and suddenly thought of pursuing a home improvement project.

    He decides to withdraw $7,000 from his IRA account to fund his project. John will have to pay taxes and a 10% penalty because he’s only 58.

  • This is an icon

    Example 3: A Withdrawing from a Traditional IRA Under an Exemption

    Diana is a successful self-made entrepreneur who dedicated most of her life to her business. Her experiences taught her to prepare for her future, so she opened a traditional IRA in her 30s to ensure she would have a sizable nest egg by retirement age.

    At 49, she realizes that she wants to start a family. Diana is not married but loves children. She began the adoption process and, after a year, finally completed it.

    She formally adopted a newborn baby girl when she was 51. Diana spent a considerable amount during the adoption process and turned to her Roth IRA account for additional financial support.

    She withdrew $5,000 without paying a 10% additional tax penalty. However, it was still taxable because it was a traditional IRA.

Traditional IRA FAQs

Not everyone is familiar with the ins and outs of a traditional IRA. MoneyGeek gathered the most commonly asked questions about it to provide more information. Equip yourself with all the information necessary to navigate your traditional IRA and future financial security.

Expert Insights

MoneyGeek reached out to industry leaders and subject-matter experts to shed more light on the intricacies of traditional IRAs. Their insights can help clarify some concepts surrounding this topic and include practical advice.

  1. What are the significant benefits of having a traditional IRA? By extension, when is a traditional IRA the more beneficial choice over a Roth IRA?
  2. When would be the ideal age or financial situation for someone to open a traditional IRA?
  3. What do people need to watch out for if they want to make withdrawals from their traditional IRAs in their retirement years (after turning 59½)?
  4. What’s the best advice you can give if people want to maximize their traditional IRAs?
Eric Jaffe
Eric Jaffe

CEO & Co-Founder of Mosaic Wealth Partners

Dustin Newton
Dustin Newton

Certified Financial Planner & Founder of Ascent Financial Group

Colby McFadden
Colby McFadden

Founder & CEO at Quiver Financial

Jaime Peters
Jaime Peters

Assistant Dean & Assistant Professor of Finance at Maryville University

Related Content

Good financial planning prevents you from worrying too much about your finances come retirement. An individual retirement account is only one aspect of planning for your future. Our guide includes several online resources that you can use to explore this subject further.

  • Planning for Financial Success: Financial planning covers a broad range of subjects. Retirement savings is one, but it’s best also to have a basic understanding of taxes and budgeting.
  • Financial Steps for Each Decade of Your Life: The earlier you prepare for your retirement, the better off you’ll be. This page explores different financial activities you can accomplish as you move from your 20s to your 60s and beyond.
  • Save It Like You Mean It: Everyone knows how crucial saving is to financial security. It’s best to have a plan that helps you determine how much you need to save to achieve your financial goals and what financial tools can help.
  • Compound Interest Calculator: Use MoneyGeek’s compound interest calculator to see how much you’ll earn from compound interest. It allows you to personalize the calculation by setting various factors such as your initial amount, contributions, interest rate and coverage period.
  • How to Start Saving and Investing: Saving and investing may seem daunting, especially if you’ve never tried doing them. MoneyGeek’s guide simplifies these and gives practical tips to get you started.
  • Smart Spending in Retirement: Just because you have a sizable nest egg for retirement doesn’t mean you should spend all of it at once. Read about different ways to live comfortably even if you don’t receive a regular paycheck.

About the Author


expert-profile

Nathan Paulus is the director of content marketing at MoneyGeek. Nathan has been creating content for nearly 10 years and is particularly engaged in personal finance, investing, and property management. He holds a B.A. in English from the University of St. Thomas Houston.