Traditional IRAs - What are the rules?

Let’s take a moment to cover traditional IRAs, one of the more popular retirement vehicles for individuals outside their retirement plan at work. 

Traditional IRAs, like Roth IRAs, are commonly used as long-term savings and investment vehicles for funding retirement. However, each has different rules concerning contributions, age requirements, and income levels that could change from year to year.

Contribution and Distribution Rules

The biggest difference between a traditional IRA and a Roth IRA is how and when taxes apply to contributions and earnings distributions.

Contributions to a traditional IRA can be deposited pre-tax (and may also be deductible on a taxpayer’s income tax return).

Additionally, investment earnings grow tax-deferred. This means that, unlike brokerage accounts, no taxes are due so long as contributions and earnings remain in the account. However, once an investor withdraws money from a traditional IRA, ordinary income taxes are only due on the amount withdrawn and are penalty-free if distributed after age 59-1/2.

Click here for up-to-date IRA contribution limits.  

Age Restrictions

Again, age 59-1/2 is the minimum age for penalty-free distributions from a traditional IRA. If distributions are taken before age 59-1/2, a 10% penalty may be assessed on your annual tax return.

That said, certain situations qualify as exceptions to the 10% penalty, such as distributions to pay first-time homebuyer expenses or qualified education expenses.

Moreover, required minimum distributions (RMDs) must begin by April 1st of the year after an individual reaches age 72, or a considerable tax penalty may apply. This rule exists to somewhat force a traditional IRA account holder to withdraw at least some of their retirement assets while they’re alive, cutting down on the buildup of a possible tax-deferred inheritance.

Income Limitations and Eligibility Requirements

One’s filing status (e.g., single or married filing jointly), income level, and participation in a retirement plan at work determine whether you’re eligible for a tax break when making contributions to a traditional IRA.

The IRS has helpful guidelines on their page concerning deduction eligibility:

• If you are covered by a retirement plan at work, click here.

• If you are not covered by a retirement plan at work, click here.

Is a Traditional IRA right for you?

As you decide which IRA – or combination of both traditional and Roth IRAs – is right for you, try to keep these two basic thoughts in mind:

• When do you anticipate needing IRA money?

• What tax benefits do you feel you need, now and long-term? 

ClearVue can help you answer these questions, and more, by developing a financial plan that meets your specific financial goals.

Let’s set up a quick consultation this week that might save you time (and money) in the future.

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