For those looking at saving for Retirement, there are a lot of options, from the 401k, to a Roth IRA and a Traditional IRA. Understanding and differentiating between them can be a little overwhelming. 

 

A Traditional IRA is an underutilized retirement account that many people do not fully understand.

 

A traditional IRA is a retirement savings account where you can use pre-tax income up to a specific max dollar amount to participate in investments that will grow tax-deferred until you make a withdrawal of funds.

 

What is tax-deferred?

To defer something is to push it off or delay doing it.

 

With a Traditional IRA, taxes are deferred to the date of withdrawal meaning that all money put into the account, including the growth of those funds while they are in the account, are not taxed until you take them out.

 

For example: if you get a paycheck for 1000 dollars and want to put in 50 dollars to a Traditional IRA you would not pay taxes on those 50 dollars.

 

So, where you would typically get taxed on the full 1000, once you deposit money into a Traditional IRA, you are only getting taxed on 950 dollars.

 

Additionally, whatever you put into your Traditional IRA, up to the maximum amount which we will talk about later, can be counted as tax-deductible meaning you can claim that as a deduction on your tax return.

 

Tax-deferred does not mean you do not pay taxes ever though.

 

Once you withdraw the money you put in you then have to pay taxes based on the tax rate bracket you are in at that time – thus, deferred taxes until later.

 

What are the pros and cons of tax deferred?

Pros

• A major pro of the tax-deferred is the ability you have to write off the money as a deduction on your tax return.

• Another is that you may be in a higher tax bracket now then you will when you retire, so it may make more sense to pay taxes later on the funds rather than now. 

• A final pro is that since you are not paying taxes on the money when you put it in, you are allowing more money to grow than you would with a Roth IRA since that is tax-free growth.

Cons

• As far as cons go, the main con is that you may be in a lower tax bracket now then you will be when you start to withdraw money so it would make sense to pay the taxes now rather than wait. 

• Another con for a traditional IRA is that if you also have a 401k, the IRS may limit the amount of your contributions to your IRA that you can deduct from your taxes.

What do I own with a Traditional IRA?

As with any investment account, there are a bunch of different options that you can own in a Traditional IRA. 

 

We have provided or are currently writing other articles to source more information on each of these.

 

As a quick summary though, the most common investment options in a IRA include mutual funds, index funds, individual stocks, bonds, ETFs, annuities, money market funds, and real estate in the form of REITs.

 

Are there risks in a Traditional IRA investment?

As with any investment, there is always risks because we are dealing with the market.

 

When you invest with a Traditional IRA you are putting your money into some sort of company where you then either own a small portion of that company or you are loaned money in conjunction with your investment.

 

As companies do well, the value of the company goes up and naturally your investment rises. 

 

But companies do not always do well.

 

There are things which occur both internally such as poor decision making and externally such as pandemics that affect how companies perform.

 

When companies do poorly, their value drops and so does your investment with them.

 

Can I put as much money as I want to into my Traditional IRA?

Sadly, the answer to this question is no.

 

As of 2021, the current contribution limit for those who are under 50 is $6,000 and for those who are over 50 the number increases to $7,000.

 

These numbers are also continually rising. From 2015-2018, the limit was $5,500 for those under 50 and $6,500 for those over 50.

 

So, for you younger investors, this is a promising trend and something to really take advantage of. 

 

Can I take any amount of money out at any time without penalty?

The simple answer to this question is no.

 

As an overarching principle, you should view the money in your IRA as untouchable due to the fact that there is a 10% early withdrawal fee before the age of 59 ½. As with most things however, there are exceptions.

 

Most of these exceptions apply to a small minority of the population, hence why I said you should view the money as untouchable.

 

I believe that the general population does not actually need to touch their retirement income until they are actually retired and having the mindset that your IRA is available funds to be used at your disposal whenever you want should be avoided.

 

Can anyone contribute to a Traditional IRA?

Under the SECURE act of 2019, those who have earned income may contribute to an IRA up until you are 70 ½.

 

Do I need to withdraw money at a certain age?

For those of you who do not know, this question is referring to required minimum distributions, or RMDs.  RMDs is the amount of money you are required to take out of your retirement accounts after a certain age.

 

In 2019 a bill was signed to change the withdrawal age to 72 for the majority of people. So, if you are currently 70 or younger, this applies to you.

 

Starting at age 72, people are required to take their RMD out. That number is not a blanket number though for everyone. 

 

According to the IRS, “The required minimum distribution for any year is the account balance as of the end of the immediately preceding calendar year divided by a distribution period from the IRS’s ‘Uniform Lifetime Table.’”

 

What that means for you, in simplified terms, is that you need to look up a worksheet or talk to a tax professional to see what the number would be for you specifically in your current situation.

 

Remember also that the number will change as your age and retirement account balance changes so this is something to continually revisit when you are at that stage of life.  

 

Should everyone open a Traditional IRA?

While there are many, many benefits to an IRA, this retirement option is not the best for everyone’s situation.

 

You should not open an IRA until you are maximizing your 401k matching contributions at work.

 

Everyone should be focused on matching their 401k at work if that is an option as their first step toward retirement. 

 

Why? Because that is free money! Before you allocate any other funds to any other retirement account, make sure you are getting the free money from your employer.

 

You also should not open an IRA if a Roth IRA makes more sense. There are certain situations that having a Roth IRA, because of its tax advantages, makes more sense. 

 

On the other side, there are situations where the ability to deduct your IRA contributions on your taxes makes more sense than a Roth IRA.

 

There is not a one size fits all answer for this question.

 

You will have to sit down and really investigate your situation and see what makes the most sense for you, your family, and your goals.

 

As you can see, an IRA provides opportunities to save money for retirement to a broad group of people while allowing for growth of the invested funds.

 

Is this a good option for you? If it is, find the best way that works for you to open one today!