Traditional IRA

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By Nathan Paulus

Updated: November 7, 2024

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What Is a Traditional IRA?

A traditional IRA is a type of retirement savings that allows you to contribute pre-tax dollars. You can invest the money in your account as stocks, bonds or mutual funds.

Investing in a traditional IRA offers several benefits, especially regarding tax. The amount you contribute can be tax-deductible, making your taxable income smaller. Simultaneously, it allows you to grow your money tax-deferred. However, distributions and withdrawals are taxed according to your tax bracket.

MoneyGeek’s guide delves deeper into the ins and outs of a traditional IRA, ranging from how to open one to what happens when you make a withdrawal. Having a clearer understanding of a traditional IRA and its function may help you decide whether it’ll work for you as you prepare for retirement.

Key Takeaways

 

The subject of traditional IRA can be overwhelming to those unfamiliar with it. At its core, here are some key points:

Traditional IRA - keyfacts.png
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A traditional IRA allows you to save for retirement using pre-tax dollars. Your earnings are tax-deferred, which means that taxes apply to your earnings less the amount contributed to your traditional IRA. It's an advantage if you foresee that you'll be in a lower tax bracket when you start making withdrawals or distributions.

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You can contribute a maximum of $6,500 for 2023. It increases to $7,500 if you're 50 or older.

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You can invest your contributions in various items, such as stocks, bonds and mutual funds.

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You can deduct your contributions from your taxable income, but your filing status, Modified AGI and whether or not you have a workplace retirement plan may limit the amount.

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You’re subjected to a 10% tax penalty if you withdraw from your account before turning 59½. However, there are several exemptions, such as using it to purchase your first home or qualify for disability.

Understanding Traditional IRAs

It’s never too early to start saving up for retirement. Having a traditional IRA (individual retirement account) is one of the ways you can set yourself up for retirement successfully.

Unlike other retirement programs or pension plans, anyone can open a traditional IRA. The only qualification is income. Once you open an account, you can begin making contributions using pre-tax funds immediately since it doesn’t have a vesting period. The sooner you put money in your account, the sooner you can start investing it.

Your contributions are tax-deductible, which allows you to lower your taxable income. Also, whatever earnings you have from your investments are tax-deferred, meaning they won’t be subjected to income tax until you make a withdrawal or distribution.

Taxable Compensation

The primary requirement for opening an account is taxable compensation. Technically, if you’re not earning, you cannot have a traditional IRA. However, not all money you receive qualifies as taxable compensation. Some examples of taxable compensation are as follows:

  • Amounts received for providing service (wages, tips and bonuses)
  • Commissions
  • Income from being self-employed
  • Taxable alimony and separate maintenance payments
  • Nontaxable combat pay

However, if you earn from renting out property, interest or dividends, you cannot use these earnings for contributions.

Your annual taxable income also determines your maximum contribution. For example, if you earn $50,000 annually, you can put in as much as $6,500 or $7,500, depending on your age. However, if you only earned $4,500 in a year, then $4,500 is the maximum contribution you can make.

Modified Adjusted Gross Income (MAGI)

A MAGI helps you determine how much of your contributions are tax-deductible.

Your allowable deduction becomes smaller if you also have a retirement plan at work and your MAGI falls within these ranges:

  • Between $109K and $129K (for a qualifying widow, widower or a married couple filing a joint return).
  • Between $198K and $204K (for a married individual filing a joint return where only your spouse has a retirement plan at work)
  • Between $68K and $78K (for a head of household or a single individual)
  • Less than $10K (for a married individual filing a separate return)

Traditional IRA vs. Roth IRA

Traditional IRA and Roth IRA share similarities, such as the option to save for retirement and the requirement to have taxable income.

However, there are distinct differences between them. Although the contribution limits are the same, those to traditional IRAs are tax-deductible if you qualify. For Roth IRAs, contributions are never deductible since you use post-tax funds. When you’re 59 ½, each time you take money out of your traditional IRA, it’s considered an income and is subjected to tax. Withdrawals from Roth IRAs are tax-free if they qualify for distribution.

The best IRA for you depends on your financial situation. If you expect to be in a lower tax bracket by the time you start making withdrawals, a traditional IRA can work for you. If not, a Roth IRA may be a better option.

Question
Traditional IRA
Roth IRA

Is there an age limit for
opening an IRA?

You can open a traditional
IRA at any age. Starting
in 2020, you can continue
contributing even if
you’re past 70½.

There is no age limit for
opening a Roth IRA.

Is there a limit to how
much I can contribute per
year?

In 2023, the maximum
amounts you can contribute
to a traditional IRA are
as follows:

  • Equivalent to your total
    taxable income for the year
  • $6,500 (for those under 50)
  • $7,500 (for those 50 and
    older)

The last two limits apply
regardless of how much
you earn.

The limits for 2023
contributions to a Roth
IRA are as follows:

  • Equivalent to your total
    taxable income for the year
  • $6,500 (for those under 50)
  • $7,500 (for those 50 and
    older)

However, your allowable
contribution may become
lower depending on your
income, filing status,
Modified AGI and whether or
not you contribute to
another IRA.

Can I deduct contributions
to an IRA?

Since you use pre-tax
dollars for traditional IRA
contributions, you may
deduct these from your
taxable income.

However, how much you can
deduct depends on several
factors. These include your
filing status, income,
whether or not you have a
retirement plan at work and
if you receive benefits
from the Social Security
Administration.

You use post-tax dollars
for your Roth IRA
contributions so none of
these are deductible.

Do I have to file a form
just because I contribute
to an IRA?

You only have to file a
form if you make
nondeductible contributions
to your traditional IRA.

You don’t have to file a
form for your Roth IRA
contributions.

Source: Internal Revenue Service (IRS)

Opening a Traditional IRA

Healthy financial planning isn’t just about maintaining a budget and spending within your means. It also includes exploring alternatives that may bring long-term benefits. A traditional IRA is an excellent example of this.

Unlike a 401(k) or other retirement plans, which your employer opens for you, you’ll have to open a traditional IRA on your own. That’s why it’s best to understand your options. MoneyGeek’s guide provides you with the necessary information to make effective financial decisions.

Opening a traditional IRA doesn’t need to be complicated. There are only five main steps involved. Our guide will cover them all, including determining whether or not you’re qualified to make contributions.

  1. 1

    Make sure you’re eligible

    This is the easy part because there is only one requirement for opening a traditional IRA — a source of taxable income. If you and your spouse receive taxable compensation, you may open separate accounts (you cannot participate in a single IRA). You can still open a traditional IRA even if your spouse is the only one earning, as long as you file a joint return.

    There is no age limit to open a traditional IRA or make contributions. Beginning 2020, you can make contributions if 70 ½ or older as long as you earn income. You can also choose to open a traditional IRA even if you have another retirement plan.

  2. 2

    Decide where to open your account

    You can open a traditional IRA at different financial organizations, such as banks, credit unions, brokerage firms and mutual fund providers. You can even look into hiring a robo-advisor. The ideal institution depends on your preferences.

    How much help do you want to manage your funds? Two popular options are having a robo-advisor or a broker. The former allows for a more hands-off approach — technology typically takes care of everything. All you need to do is check your dashboard. However, a brokerage may be better if you’re not too tech-savvy or prefer a full-service experience.

  3. 3

    Accomplish the necessary paperwork

    Like any other financial account, you’ll need to present documentation and provide information to open it. These include the following:

    • A government-issued credential, such as your passport or driver’s license
    • Your personal details, including your complete name, contact number, birthday and social security number
    • Your beneficiaries’ information
    • Your preferred contribution method

    If you want to deposit funds through a bank transfer, you need to provide your bank details. You can also have money rolled over from another retirement account, such as a 401(k), but it will require you to fill out some forms.

  4. 4

    Choose where your traditional IRA goes

    One benefit of having a traditional IRA is you have several options regarding where you can invest your money. Here are some that you might consider:

    • Stocks require that you buy shares of publicly traded companies.
    • Bonds might be your best option if you prefer low-risk investments that generate a predictable income stream. These are debt securities, like an IOU.
    • Mutual funds are less risky because you aren’t putting your eggs in one basket. A company pools money from multiple investors and invests it in a range of companies across different industries. Fund managers also do a lot of legwork for you, such as researching and selecting securities.
    • Exchange-traded funds (ETFs) are similar to mutual funds but trade money on a national stock exchange.

    Depending on your financial goals and your level of risk-averseness, your evaluation of these options can show you what works best for you.

  5. 5

    Start your contribution

    An automatic transfer from your bank account can be an effective way to ensure you make regular contributions to your traditional IRA. However, it’s not a requirement.

    You can adjust the frequency and amount of your contribution depending on your comfort level. You don’t need to put something in the account every month, nor does it have to be the same amount each time.

    However, you do need to keep the contribution limits in mind. For 2023, the maximum is $6,500 (or $7,500 if you’re 50 or older). If your annual taxable income is less than that, your contribution limit for the year will also adjust.

Traditional IRA Contributions & Deductibles

A significant benefit of having a traditional IRA is that your contributions are tax-deductible. You can subtract it from your total taxable income when filing your return. As a result, you’ll owe less in taxes.

There are instances that even if you contribute the maximum amount for the year, you won’t be able to deduct everything. Your modified adjusted gross income (MAGI), your filing status and whether or not you (or your spouse) are covered by a retirement plan at work affect your allowable deductible.

Knowing how to compute for your MAGI helps you see whether you can make a full deduction, a partial one or if it isn’t possible.

MoneyGeek’s guide elaborates on this further. The first table below tackles the situation wherein you have a retirement plan at work. The second table covers the scenario of your traditional IRA as your only retirement savings plan.

You can use these two tables as a guide, making it easier to determine how much of a deduction you can make, if any. It may even help you make the most of your deductibles and make better financial decisions.

Contribution & Deduction for Individuals With Retirement Plans at Work

Having a retirement plan at work is a good thing. One advantage is that your employer manages it, and you can roll the amount over to a new 401(k) or a different retirement account if and when you leave that employer. However, many deduction limits would apply based on your MAGI.

There are only three instances wherein you can deduct your entire contribution. Everything else would result in a partial or no deduction.

Filing Status
Modified Adjusted Gross Income (MAGI)
Deduction Amount

Single or head of
household

$68,000 or less

A full deduction up to the
amount of your
contribution limit

Single or head of
household

More than $68,000 but less
than $78,000

A partial deduction

Single or head of
household

$78,000 or more

No deduction

Married filing jointly or
qualifying widow(er)

$109,000 or less

A full deduction up to the
amount of your
contribution limit

Married filing jointly or
qualifying widow(er)

More than $109,000 but
less than $129,000

A partial deduction

Source: Internal Revenue Service (IRS)

Contribution & Deduction for Individuals Without IRA Plans at Work

You can make a full deduction if you and your spouse don't have a retirement plan at work, regardless of your MAGI. However, you’ll need to consider your MAGI when your spouse’s employer provides a company-sponsored retirement account.

It’s still possible to be in a situation where you can make a full deduction, but most scenarios have a different outcome. Fortunately, the MAGI limits are typically higher compared to if you have a retirement plan at work.

Filing Status
Modified Adjusted Gross Income (MAGI)
Deduction Amount

Single, head of household,
or qualifying widow(er)

Any amount

A 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

A full deduction up to the
amount of your
contribution limit

Married filing jointly
with a spouse who is
covered by a plan at work

$204,000 or less

A full deduction up to the
amount of your
contribution limit

Married filing jointly
with a spouse who is
covered by a plan at work

More than $204,000 but
less than $214,000

A partial deduction

Married filing jointly with
a spouse who is covered by
a plan at work

$214,000 or more

No deduction

Source: Internal Revenue Service (IRS)

Withdrawing Funds From Your Traditional IRA

The primary purpose of having a traditional IRA is to have a nest egg by your retirement age. You’re required to take annual distributions when you turn 72. Yes, these will be taxable.

You can’t avoid taxes when you take money from your account — that’s the payoff from letting your funds grow tax-deferred. However, making a withdrawal before turning 59 ½ means paying an additional 10% tax.

Fortunately, there are several ways to avoid this. Here are nine scenarios that serve as exemptions, excusing you from paying the penalty.

  1. 1

    Purchasing, building or rebuilding your first home

    The IRS considers you a first-time homebuyer if you haven’t owned a home (besides the one you have if you’re rebuilding) in the last two years. You can withdraw up to $10,000 from your account and put it towards buying a house, regardless if it's for you, your children or your grandchildren.

    If your spouse also has a traditional IRA, they can withdraw the same amount from their account. However, timing is essential in this scenario. You need to use the distribution within 120 days of your withdrawal.

  2. 2

    Paying for higher education expenses

    You can use the funds from your account to fund qualified higher education expenses. These cover the tuition, miscellaneous fees, supplies, equipment and books you need to enroll. The student doesn’t necessarily have to be you — it can be anyone in your immediate family.

  3. 3

    Welcoming a child (through birth or adoption)

    You have a $5,000 limit per adoption or birth. You must take the distribution within one year of your child’s birth or the finalization of the adoption. For the latter, your adoptee must be younger than 18 or someone who can’t self-support due to their physical or mental state.

  4. 4

    Covering unreimbursed medical expenses

    You can use IRA funds to pay for unreimbursed medical expenses beyond 7.5% of your adjusted gross income.

    For example, say you earn $120,000 annually. Then, 7.5% of that is $9,000. If you have unreimbursed medical expenses reaching $20,000, your IRA can cover $11,000.

  5. 5

    Paying for health insurance

    You can use your IRA money to pay for health insurance premiums if you lose your job. You are still exempt from the additional tax if you receive the distribution within 60 days of when you start working again.

  6. 6

    Arranging for substantially equal periodic payments

    You can arrange to make penalty-free regular withdrawals from your traditional IRA, which allows you to receive a specific amount for five years or until you turn 59 ½, whichever comes first.

    If you decide to go in this direction, remember that you cannot stop it in the middle of the process. Otherwise, you will incur a penalty.

  7. 7

    Having a permanent disability

    Becoming physically or mentally disabled may prevent you from doing substantial gainful activities. In situations like these, you may use your IRA funds before turning 59 ½ without paying additional tax.

    A physician must certify that your condition may lead to your passing or will last indefinitely (at least a prolonged period).

  8. 8

    Inheriting an IRA

    If you have an existing IRA account at your passing, your beneficiaries or estate will receive your assets without paying the additional 10% tax.

    On the other hand, if your spouse passes and you inherit a traditional IRA, you will pay the penalty for any distribution you receive before you turn 59 ½ if you choose to treat it as your own.

  9. 9

    Being called to active duty

    Military members can receive distributions penalty-free but only when on active duty.

Withdrawal Examples

Several factors can affect your IRA withdrawal experience. Knowing whether you qualify for an exemption or if your distribution is qualified can help you determine whether or not you pay a penalty.

Here are three situations wherein different IRA owners made withdrawals from their funds. As you’ll notice, some encountered a 10% penalty, while others didn’t. You can compare their situations to see how circumstances affected their withdrawals.

    seniors icon

    Example 1: A Traditional IRA Withdrawal After Turning 60

    Elizabeth opened her traditional IRA in her forties. She has been very consistent in her contributions, and now that she’s about to turn 60, she has $100,000 in her account.

    Elizabeth knows that she’ll need to take annual distributions when she turns 72 but decides that she wants to take some money out to visit her son and his family, who currently live in California.

    Elizabeth decides to withdraw $10,000 from her traditional IRA on her 60th birthday. That amount is now taxable, and she’ll have to pay the corresponding amount in tax based on her current tax bracket.

    man icon

    Example 2: A Non-Qualified Distribution from a Traditional IRA

    John wasn’t very keen on his finances until he was near retirement age. Only after repeated requests from his daughter did he finally open an IRA. Although he was already 55, John thought it was better late than never.

    That was three years ago. John chose to retire early and now finds himself at home more often. He lives alone in the first home he and his wife bought when they married and suddenly thought of pursuing a home improvement project.

    He decides to withdraw $7,000 from his IRA account to fund his project. John will have to pay taxes and a 10% penalty because he’s only 58.

    teen icon

    Example 3: A Withdrawing from a Traditional IRA Under an Exemption

    Diana is a successful self-made entrepreneur who dedicated most of her life to her business. Her experiences taught her to prepare for her future, so she opened a traditional IRA in her 30s to ensure she would have a sizable nest egg by retirement age.

    At 49, she realizes that she wants to start a family. Diana is not married but loves children. She began the adoption process and, after a year, finally completed it.

    She formally adopted a newborn baby girl when she was 51. Diana spent a considerable amount during the adoption process and turned to her Roth IRA account for additional financial support.

    She withdrew $5,000 without paying a 10% additional tax penalty. However, it was still taxable because it was a traditional IRA.

Traditional IRA FAQs

Not everyone is familiar with the ins and outs of a traditional IRA. MoneyGeek gathered the most commonly asked questions about it to provide more information. Equip yourself with all the information necessary to navigate your traditional IRA and future financial security.

How much do I need to open a traditional IRA?

Is a traditional IRA the same as a 401(k)?

Can I transfer my 401(k) to a traditional IRA?

Can I have both a traditional IRA and a Roth IRA simultaneously?

Is a traditional IRA better than a Roth IRA?

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About Nathan Paulus

Nathan Paulus headshot

Nathan Paulus is the Head of Content Marketing at MoneyGeek, with nearly 10 years of experience researching and creating content related to personal finance and financial literacy.

Paulus has a bachelor's degree in English from the University of St. Thomas, Houston. He enjoys helping people from all walks of life build stronger financial foundations.

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