Traditional IRA

Key takeaways

• A traditional IRA is a tax-deferred retirement account funded with pre-tax (or deductible) contributions; investment growth is taxed on withdrawal.
• Withdrawals are taxed as ordinary income; distributions before age 59½ generally incur a 10% penalty unless an exception applies.
• Annual contribution limits (2024–2025): $7,000 for those under 50; $8,000 for age 50+ (includes $1,000 catch-up).
• Required minimum distributions (RMDs) begin based on birth year; deadlines and ages changed under recent law updates—check current IRS guidance for your cohort.
• Deductibility of contributions can be limited by participation in an employer plan and by modified adjusted gross income (MAGI).

What is a Traditional IRA?

A traditional individual retirement account (IRA) lets you contribute taxable compensation and potentially deduct those contributions on your tax return. Funds grow tax-deferred: you pay ordinary income tax on withdrawals in retirement. Custodians (banks, brokerages, robo-advisors) hold the account and invest funds according to your instructions.

How contributions and taxation work

• Contributions: You may contribute up to the annual limit (see Key takeaways). To contribute, you must have eligible taxable compensation (wages, self-employment income). Spouses may each have their own IRA if conditions are met.
• Tax treatment: Contributions are often tax-deductible (subject to income limits and whether you’re covered by an employer plan). Earnings grow tax-deferred. Withdrawals are taxed at your ordinary income tax rate.
• Deadline: Contributions for a tax year must be made by the tax-filing deadline the following spring (usually around April 15).

Contribution limits and catch-up

• 2024–2025 limits: $7,000 for under 50; $1,000 catch-up for age 50 and older (total $8,000).
• You can contribute up to the lesser of the annual limit or your earned compensation for the year.

Deductibility when covered by an employer plan

If you (or your spouse) participate in an employer retirement plan, the ability to deduct traditional IRA contributions is phased out based on MAGI:
* Single filer covered by a workplace plan (2024): full deduction below $77,000; phased out $77,000–$87,000; no deduction at $87,000 or more. (2025: $79,000/$89,000.)
* Married filing jointly with a covered spouse (2024): full deduction below $123,000; phased out $123,000–$143,000; no deduction at $143,000 or more. (2025: $126,000/$146,000.)
Check IRS rules each year for updated thresholds.

Distributions and penalties

• Age 59½: Withdrawals after this age are generally penalty-free (but still taxable).
• Early withdrawals: Distributions before 59½ are subject to ordinary income tax plus a 10% penalty unless an exception applies.
• Exceptions to the 10% early-withdrawal penalty include (non-exhaustive):
• First-time home purchase (up to $10,000 lifetime)
• Qualified higher-education expenses
• Disability
• Unreimbursed medical expenses that exceed IRS limits
• Periodic substantially equal payments (SEPP)
• Medical insurance premiums after job loss
• Distributions made to beneficiaries after the owner’s death
• IRS levy or certain military active-duty call-ups
• Return of nondeductible contributions
  Confirm eligibility for exceptions with a tax advisor or IRS guidance.

Required Minimum Distributions (RMDs)

RMD rules have been updated over time; the starting age depends on your birth year. RMDs must be withdrawn by December 31 each year (with a one-time option to delay the first RMD until April 1 of the year after you reach the applicable starting age). Because rules have changed, verify the correct starting age for your birth year with current IRS information.

Traditional IRA vs. Roth IRA

• Traditional IRA: Contributions may be tax-deductible; withdrawals in retirement are taxed as ordinary income; RMDs apply.
• Roth IRA: Contributions are made with after-tax dollars (not deductible); qualified withdrawals (including earnings) are tax-free if you meet age and holding-period requirements; Roth IRAs do not have RMDs for the original owner. Roth contribution eligibility is phased out at higher incomes.

Employer-based IRAs: SIMPLE and SEP

• SEP IRA: Employer-established plan (common for self-employed or small-business owners). Only employers contribute; higher contribution limits than traditional IRAs; employer contributions are deductible to the employer and immediately vested for employees.
• SIMPLE IRA: For small employers (generally ≤100 employees). Employer must make either a fixed 2% non-elective contribution or a matching contribution up to 3%. Employee contribution limits are higher than standard IRAs, and catch-up limits apply for older workers.
  Both operate similarly to traditional IRAs for tax-deferred growth but are established and funded by employers under different rules.

Opening and managing a Traditional IRA

• Where to open: Banks, brokerages, mutual fund companies, robo-advisors, and financial advisors commonly offer IRAs.
• Contributions: Accepted as cash (checks, electronic transfer). Physical property is not an acceptable form of contribution.
• Investments: You control the investment choices within the account, subject to the custodian’s offerings.
• No minimum balance is generally required to open an account, though investment minimums for particular funds may apply.

Retirement Security Rule (fiduciary rule)

A regulatory change called the Retirement Security Rule (issued by the Department of Labor in 2024) tightens standards for advisers giving retirement investment advice. It clarifies when advisors act as fiduciaries under ERISA and aims to reduce conflicts of interest for advice used to build retirement savings. If you work with an advisor, know whether they’re held to a fiduciary standard for your retirement accounts.

Advantages and disadvantages

Advantages:
* Immediate tax benefit if contributions are deductible.
* Tax-deferred growth may lower current taxable income.
* Flexible investment choices.

Disadvantages:
* Withdrawals are taxed as ordinary income.
* Early withdrawals face a 10% penalty unless an exception applies.
* RMDs force distributions at certain ages.
* Deductibility can be limited by income and employer plan participation.

Bottom line

Traditional IRAs are a widely used retirement vehicle that offer tax-deferred growth and potential current-year tax deductions. They are most beneficial if you expect to be in a lower tax bracket in retirement or want to lower current taxable income. Rules on contribution limits, deductibility, RMDs, and exceptions are specific and subject to change—consult current IRS guidance or a tax professional when planning or taking distributions.