IRA's 101

What You Need to Know About Traditional IRA's

Simplified Definition:

A Traditional IRA is a tax deferred retirement vehicle. Contributions to a Traditional IRA plan may be tax deductible depending on the taxpayer’s income, tax filing status and other factors. Contributions to Traditional IRAs are made on a pre-tax basis, meaning the money is invested before it is taxed.
The benefit to investing pre-tax money is that it has the potential to lower your current tax bracket, and your money can grow tax free until you withdraw it. Qualified withdrawals are treated as ordinary income and may be subjected to income tax.

Income limits:

Everyone is eligible to contribute to a Traditional IRA, but not everyone will get the benefit of a tax deduction.

Withdrawals:

Traditional IRA holders are eligible to withdraw from their IRA at age 59 ½, at which point their withdrawals are taxed as ordinary income. There are stiff penalties for early withdrawal (with certain exceptions).

Required Minimum Distributions:

Owners of Traditional IRAs are subjected to Required Minimum Distributions, which begin at age 70 ½. This means Traditional IRA holders are required to make a minimum withdrawal every year regardless of whether or not they need the money.

Advantages of a Traditional IRA:

There are several advantages for investing in a Traditional IRA, and they primarily deal with taxes. The tax savings at the time of investment may be enough to decrease your taxable income to a lower tax bracket. Many retiree’s income is lower in retirement years; thus they may have a lower tax rate when they withdraw their funds. Depending on your income, you may be able to use a Traditional IRA to lower your tax bracket during your working years, and then withdraw your money in retirement in a low tax bracket.

Disadvantages of a Traditional IRA:

The minimum required distribution is a disadvantage because it requires IRA holders to withdraw a certain portion of their funds – whether they want to or not. It is also difficult to determine what your tax rate will be in retirement.