Traditional IRAs let you invest for your retirement while reducing your tax burden. This means that you get the benefits of a traditional retirement account, but don’t have to pay taxes until you withdraw the money. When you withdraw from the account in retirement, you pay taxes at your future current tax rate.
What is a traditional IRA? Pros, cons, and how to get started
TL;DR
Traditional IRAs are retirement accounts that let you invest funds and pay tax when you withdraw for retirement.
You can open a traditional IRA at a brokerage, bank, or robo-advisor. Depending on your plan, you can invest in the stock market, buy bonds, or purchase CDs.
Traditional IRAs have limits on how much you can contribute in a year, when you can take out your money without a penalty, and who qualifies for tax breaks.
Thinking about your future with a traditional IRA.
Public lets you invest for the long term, helping you build wealth and save for retirement.
What is a traditional IRA?
Traditional IRAs, or individual retirement accounts, are a kind of investment account that lets you save for retirement while deferring your tax liability. Traditional IRA contributions are usually tax-deductible, meaning they can offset current year income and that you don’t pay taxes on your investments until you start to withdraw in retirement.
Traditional IRAs and Roth IRAs are different. Roth IRAs let you contribute post-tax dollars. Financial advisors often recommend traditional IRAs to those whose tax liability will be the same or lower in retirement, while Roth IRAs are generally preferable for those whose tax liability will increase in retirement.
How does a traditional IRA work?
Money put into a traditional IRA is considered tax-deferred, meaning that you usually don’t pay taxes until you withdraw in retirement. At that point, you’ll pay federal income tax on your retirement income the same you would on ordinary income.
While IRAs can be a highly useful way to save for retirement, there are certain limitations on how much money can be invested, when withdrawals can occur, and who can claim the tax benefit:
- You can contribute a maximum of $6,000 per year in 2022 (or $7,000 if you’re over 50). Annual contribution limits for IRAs are in addition to anything you contribute to a 401(k) or other workplace savings account. If you have a spouse, you can each contribute to separate accounts up to the annual maximum.
- Withdrawing early usually carries a penalty. If you choose to withdraw from your account early (before you turn 59 ½), you’ll likely pay a 10% early withdrawal penalty on top of your standard income tax.
- At a certain age, you’ll be required to take distributions. You don’t have to start withdrawing as soon as you’re eligible, but you will have to start taking required minimum distributions (RMDs). The current age limit for RMDs is 72 for most younger investors.
- Tax advantages depend on your income and workplace retirement plans. Not everyone can make deductible contributions. If you have a workplace retirement plan, you may still need to pay taxes on your traditional IRA, depending on your income and filing status. The IRS sets the limits for income that qualifies for deductions according to your modified adjusted gross income (MAGI) on your tax return.
Opening a traditional IRA
You can open a traditional IRA at a brokerage, bank, or robo-advisor. Bank IRAs tend to emphasize CDs or savings accounts, while those from brokerages or robo-advisors tend to offer stocks and bonds.
Investors who choose to open a brokerage account will receive a list of investment options to choose from.
Quick Tip
If you’re looking to invest in a certain sector and already have your retirement plans in place, Public’s Invest in Themes feature makes it easy to choose investments according to industry or interest.
If you prefer a less hands-on approach to your retirement savings, a robo-advisor can invest your funds automatically using information about your time horizon and investing goals.
Who is eligible to open a traditional IRA?
Anyone with earned income is eligible to open a traditional IRA, even if they already have an employer-sponsored retirement plan. However, you must make at least as much in taxable income as you contribute to the IRA. For example, if you contribute $6,000 to your IRA, you must have made at least $6,000 in taxable income that year.
Remember that income limits apply to traditional IRA’s tax deductions. If your MAGI is above a certain level, you may not be able to claim the full deduction. You can still contribute to your IRA, but you will be responsible for reporting taxes paid when you withdraw at retirement.
IRAs are just one part of a long-term strategy for investors looking to build wealth. If you’ve exceeded your annual maximum IRA contribution or simply want to take advantage of a more liquid investment account, Public’s Long-Term Portfolio can help you lock in investments for the long haul. Then, you can share why you’ve invested for the long-term and tell your fellow investors why you believe in your investment.
Thinking about your future with a traditional IRA.
Public lets you invest for the long term, helping you build wealth and save for retirement.
Frequently asked questions
Do traditional IRA investments grow tax-free?
Contributions to traditional IRAs are usually eligible for a tax deduction. However, this depends on your income. Once funds are in the account, investments grow tax-free until withdrawal.
Is a traditional IRA the same as a 401K?
A traditional IRA is different from a 401(k). IRAs are individual retirement accounts that are not connected to your employer, and you can have one in addition to a 401(k).
Can you roll over a traditional IRA?
Yes, you can roll over a traditional IRA into a 401(k) if you’re looking to consolidate your retirement accounts. You can also roll over 401(k) accounts into a traditional IRA for more flexibility. Additionally, you can perform a Roth conversion to convert a traditional IRA into a Roth IRA.
Can I take an early withdrawal from my traditional IRA without a penalty?
Any early withdrawals from a traditional IRA will be subject to a 10% penalty. The only exception to this is if you roll over your traditional IRA into a 401(k) or convert it to a Roth IRA.