Introduction

The traditional IRA is a popular way to save for retirement. According to the Investment Company Institute, some 17 million households had conventional IRAs in 2022.

That’s nearly three times as many as in 2007 before the Great Recession. It’s not hard to see why: Traditional IRAs offer tax-deferred growth on your investments and provide an attractive way for low- and middle-income workers to build a nest egg for their golden years.

What exactly are traditional IRAs? How do they work? And how do you open one if you’re looking for retirement savings options? We’ll answer all these questions (and more) below.

What is a Traditional IRA?

A Traditional IRA is a retirement savings account that allows you to save for retirement by lowering your taxable income. You can contribute up to $6,000 annually, with an additional $1,000 allowed if you’re 50 or older.

While it’s not necessary to be employed (self-employed individuals are eligible), the amount you earn determines how much you can contribute from your salary into an IRA each year.

It may be tempting to start contributing when you first begin working and earning money; however, there’s no harm in waiting until after age 70½ before opening your first traditional IRA account. Doing so could help increase the size of your nest egg.

You can contribute directly through an employer or invest on your own with a brokerage firm or financial institution such as Vanguard or Fidelity.

What Are the Benefits of a Traditional IRA?

You can contribute to a traditional IRAs until your tax return’s the due date, typically April 15 (or October 15 if you file an extension).

The contribution is deductible from your taxable income, reducing how much you pay in taxes this year.

You don’t pay taxes on the interest or earnings until you withdraw money from the account at retirement age (and even then, only on withdrawals for non-qualified purposes).

What is an example of how a traditional IRA works?

Assume you have a traditional IRA worth $5,000.

When you make a contribution to a traditional IRA, the amount of your contribution is added to your taxable income for that year.

Since there are no taxes on funds inside an IRA account (unless they are withdrawn while still within the account), you don’t need to pay any additional taxes on this money until later when and if it’s removed from your account.

You can also withdraw funds without paying taxes or penalties; however, any earnings (interest earned on investments) in the account must be untouched until age 59½ before they can be withdrawn without penalty.

Maintaining an open traditional IRA lets you continue growing those funds tax-deferred, meaning there will be no taxes owed when withdrawals are made from the account during retirement years and allow flexibility regarding how much money gets put away each year during working years versus how much gets taken out during retirement years.‎

Who Can Open a Traditional IRA?

Anyone who meets the following requirements:

To contribute, you must have earned income from a traditional IRA (or be married and filing jointly with your spouse).

You must be 18 years of age or older.

You cannot be a full-time student or dependent on another person’s tax return.

How to open a traditional IRA?

You can open a traditional IRA with any bank or brokerage firm that offers IRAs.

If you need help opening a traditional IRA, many financial institutions have customer service representatives who can walk you through the process.

A typical traditional IRA has a minimum investment of $1,000 to open and no maximum contribution limit (although there are tax implications of making too enormous a contribution).

Are contributions to a traditional IRA tax deductible?

If you are under 70.5 years old, then contributions to a traditional IRA can be deducted from your income. Once you reach that age, however, you can still contribute to an IRA but will not be able to take a deduction for those contributions.

You can deduct your contributions if you are under 70.5 years old and make them even after that until the day you turn 70 ½ (the age at which people must begin taking required minimum distributions).

For example, if someone reached the age of 65 on January 1 and decides they want to start contributing money into their account immediately without waiting until April 15, when it would open up again for new contributions for this year, they could still do so even though it turned 65 already.

How much can I contribute to my traditional IRA?

The annual contribution limit for participants under age 50 is the lesser of $6,000 or your taxable compensation.

For those who are 50 or older, the limit increases to $7,000 annually.

If you have self-employment income that isn’t subject to employment taxes, such as freelance writing or acting, you can also contribute up to 100% of your net earnings from this source up to a maximum of $6,000 per year (or $7,000 for taxpayers age 50 and older).

If your spouse works but doesn’t receive any social security benefits from his job (unlikely), he may also contribute up to 100% of his net self-employment income; his limit is the same as yours (in addition to a traditional IRA account for each spouse’s benefits).

What happens if I don’t meet the income requirements for a Roth IRA

If you don’t meet the minimum income requirements for a Roth IRA but want to contribute more than $6,000 to your traditional IRA every year, there is an easy way to do it.

You can open a traditional IRA, contribute up to the limit ($6,000 in 2021), and then convert it into a Roth. You will owe taxes on any amount you convert from your traditional IRA into your Roth.

This process can only be done once per 12 months; otherwise, you’ll have to pay taxes for both years on whatever portion of your combined contributions falls outside those limits.

What Is the Difference Between a Traditional and Roth IRA?

The Traditional IRA is tax-deferred, which means you don’t pay taxes on the money you put in now and won’t have to pay taxes when you take it out. However, your withdrawals are taxable.

With a Roth IRA, your contributions are not tax deductible, but any withdrawals will be tax-free as long as you’ve had your account for at least five years and are over 59½ years old (and have held an account for at least five).

Traditional IRAs are significant savings

Traditional IRAs are excellent savings vehicles, but it’s essential to understand how they work. Both traditional and Roth IRAs are tax-advantaged retirement savings vehicles. Traditional IRA contributions may be tax deductible.

However, all withdrawals in retirement will be taxed as ordinary income, and you’ll pay an early withdrawal penalty if you take money out before age 59½.

Contributions for the year can’t exceed $6,000 (or $7,000 if you’re 50 or older).

Conclusion

The bottom line is that traditional IRAs are a great way to save for retirement. They have many benefits and are easy to open and manage. However, it would help if you understood how they work before opening one so that you don’t make costly mistakes