A Traditional Individual Retirement Account (IRA) is one of the most powerful tools available to American workers for building a secure retirement. This guide breaks down exactly how it works and why you might want one.
What is a Traditional IRA?
A Traditional IRA is a tax-advantaged personal savings plan where contributions may be tax-deductible. The defining feature of a Traditional IRA is that your money grows tax-deferred. You don't pay taxes on the investment gains or dividends as long as the money remains in the account.
Key Benefits
- Tax Deductions Now: Depending on your income and whether you or your spouse are covered by a retirement plan at work, your contributions may be fully or partially tax-deductible.
- Tax-Deferred Growth: Your investments compound faster because taxes aren't dragging down your annual returns.
- Wide Range of Investment Options: Unlike many employer-sponsored 401(k)s, a Traditional IRA allows you to invest in almost any stock, bond, mutual fund, or ETF.
When Do You Pay Taxes?
The IRS will eventually want their cut. With a Traditional IRA, you pay ordinary income tax on your withdrawals during retirement. The logic is that you will likely be in a lower tax bracket when you retire than you were during your peak earning years.
Required Minimum Distributions (RMDs)
Starting at age 73 (for those born between 1951 and 1959) or 75 (for those born in 1960 or later), the IRS requires you to start withdrawing a minimum amount from your Traditional IRA each year. Failure to take RMDs results in severe tax penalties.
Is a Traditional IRA Right For You?
A Traditional IRA is generally best if you expect your tax rate in retirement to be lower than your current tax rate. If you are currently in a high tax bracket and need immediate tax relief, maximizing your Traditional IRA contributions is a smart strategy.