What is a traditional IRA?

A traditional IRA is a tax-advantaged individual retirement account that allows you to set aside pre-tax dollars for your retirement. If you want to put off your tax bill while you save for your retirement, setting up a traditional IRA is the wise move.

Traditional IRAs are especially ideal if you think that a lower tax rate will apply to you in retirement. The younger you are when you open your traditional IRA, the greater your saving potential because you get tax-free compounding working longer and harder for you.

Traditional IRA
How does a traditional IRA work?

Everyone is eligible to open a traditional IRA as long as they have income that meets Internal Revenue Service (IRS) requirements. As opposed to the Roth IRA, traditional IRAs come without an income cap, meaning that you can open such an account regardless of the size of your paycheck. Note, however, that contribution limits still apply, and for the 2021 tax year these are $6,000 per year, or $7,000 if you're 50 or older.

You may be able to deduct the contributions you pay into a traditional IRA and you pay taxes on your investment gains only when you make withdrawals in retirement. The amount you can deduct depends on your modified adjusted gross income (MAGI) and whether you or your spouse have a retirement plan at work. Consult the following tables to see if you are eligible to deduct your traditional IRA contributions.

Tax deductions for traditional IRA holders with a retirement plan at work
Filing status MAGI amount in 2021 Amount of tax deduction
Single or head of household $66,000 or less Full deduction up to the amount of your contribution limit
More than $66,000 but less than $76,000 Partial deduction
$76,000 or more No deduction
Married filing jointly or qualifying widow(er) $105,000 or less Full deduction up to the amount of your contribution limit
More than $105,000 but less than $125,000 Partial deduction
$125,000 or more No deduction
Married filing separately Less than $10,000 Partial deduction
More than $10,000 No deduction

Note: If you file separately and did not live with your spouse at any time during the year, your IRA deduction is determined under the "single" filing status.

Tax deductions for traditional IRA holders without a retirement plan at work
Filing status MAGI amount in 2021 Amount of tax deduction
Single, head of household, or qualifying widow(er) Any amount 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 Full deduction up to the amount of your contribution limit
Married filing jointly with a spouse who is covered by a plan at work $198,000 or less Full deduction up to the amount of your contribution limit
More than $196,000 but less than $208,000 Partial deduction
$208,000 or more No deduction
Married filing separately with a spouse who is covered by a plan at work Less than $10,000 Partial deduction
More than $10,000 No deduction

Note:  If you file separately and did not live with your spouse at any time during the year, your IRA deduction is determined under the "single" filing status.

Traditional IRA
Tax advantages and withdrawal rules

Traditional IRAs offer two tax advantages: tax deductions and tax-deferred investment growth. If your income is lower than the limits outlined in the table above, deducting your contributions will significantly reduce your tax bill.

Say your annual income is $80,000 and you contribute $6,000 to your traditional IRA. If you qualify, your taxable income is reduced to $74,000. If your tax rate is 22%, you end up saving $1,320 in taxes for the year.

In addition to tax deductions, tax-deferred investment growth can in certain circumstances double the value of your investments in the long term compared to a brokerage account.

When you withdraw money from your traditional IRA account, you will owe income taxes on those funds based on your current income tax bracket. Both your contributions and your earnings will be taxed. Generally speaking, you gain penalty-free access to your money once you reach the federal retirement age of 59 ½.

When you turn 72, you must start taking so-called required minimum distributions (RMDs) from your traditional IRA account. The IRS determines the amount you must withdraw based on the size of your account and your life expectancy. Failing to withdraw RMDs will result in a painful penalty of 50% of the amount that should have been withdrawn.

If you need the money before you reach the legal retirement age, you will have to pay an early withdrawal penalty of 10% in addition to the taxes that are due on the withdrawn money. There are some exceptions when you can take out your money from your IRA before you turn 59 ½. If you use the funds for any of the following reasons, you will not be required to pay the early withdrawal penalty. 

  • First-time home purchase (up to $10,000)
  • Birth or adoption of a child (up to $5,000)
  • Qualified higher education expenses
  • Qualified medical expenses
  • Health insurance premiums when unemployed
  • You have died and the funds are withdrawn by a beneficiary

Take into account that these withdrawals will still trigger income tax payment obligation.

Author of this article

Edith Balázs

Author of this article

Having spent the better part of the past two decades as a financial journalist at international media outlets, Edith enjoys researching complex topics and stripping them of the unnecessary clutter to arrive at clear and easy-to-understand copy.

Edith Balázs

Senior Editor

Having spent the better part of the past two decades as a financial journalist at international media outlets, Edith enjoys researching complex topics and stripping them of the unnecessary clutter to arrive at clear and easy-to-understand copy.

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