In researching the best options for the retirement accounts that will help you build a retirement nest egg; you will inevitably come across this thing known as a Traditional IRA. But what is it exactly, and why is it considered “traditional” as opposed to Roth? And what separates an IRA from a 401(k)? Let’s look at what you can do with a Traditional IRA and how to contrast these accounts with other strategies you might come across.
Defining the Traditional IRA
A Traditional IRA is a straightforward retirement arrangement. The IRS defines it simply as “a way to save for retirement that gives you tax advantages.” You contribute money to this account, and it grows tax-deferred, allowing you to stack as much money as possible over the course of a lifetime. But let’s get into the specifics of how this arrangement works and why you might want to use one:
- The common IRA, a pretax Traditional IRA, allows you to make retirement contributions now and deduct those contributions when you file your taxes. This is a great advantage for someone with a slim margin in their budget, but who still want to make retirement contributions for their long-term benefit.
- It’s also possible to make “nondeductible contributions” to a Traditional IRA, but keep in mind that this is not the same as an arrangement in which you contribute to a Roth IRA—in which qualified distributions will be tax-free. If you expect to have a higher tax rate in retirement than you do now, it’s usually recommended that you sign up for a Roth IRA.
Because of the structure of the Traditional IRA, it’s a great independent option for people who are making enough money now that they expect that they might be in a similar tax bracket in the future, when they take the distributions from the IRA.
Contribution Limits within a Traditional IRA
For many people, the question is simple: how much can you contribute to a retirement account? While there may be other features to consider, this is one of the most important—especially for someone with plenty of income to spare and not a lot of money in retirement accounts.
A Traditional IRA features contribution limits of $6,000 in 2019, and $7,000 if you are age 50 or older. That includes total contributions to all IRAs, however, which is why it will be important to choose either a Roth IRA or a Traditional IRA—there’s usually no benefit to having both. In addition, a IRA will no longer allow contributions in the year you’ve made it to the age of 70 ½ or older.
When Can You Withdraw from a Traditional IRA?
Let’s say that you plan on retiring early. How soon can you start taking money out of your IRA to help supplement your retirement income? The current age is 59 ½, at which point you can withdraw funds from your Traditional IRA without additional restrictions. However, these will be subject to ordinary income taxes. In addition, once you reach the age of 70 ½, you will start having to take out Required Minimum Distributions (RMDs) rather than continue to let the account grow as-is.
Using Traditional IRAs, investors can use this money towards nontraditional assets, including real estate, precious metals, and even tax liens. But it helps to have a thorough understanding of accounts like the Traditional IRA before getting started with a new retirement plan, especially if self-directing your own accounts.