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What is a Traditional IRA?

2016-11-21T15:56:13+00:00

The term 'Traditional IRA' is included in the Investments edition of the Financial Dictionary. Get yours now on amazon in ebook or paperback format. Read more here...

The Traditional IRA is the most common type of the various individual retirement accounts available to savers for retirement. Besides this type of IRA, there are also SEP IRAs, Roth IRAs, and Self Directed IRAs. Each of these types of accounts has at least a few features in common with the original and still most popular plain IRA.

These accounts are all particularly designed to help save, grow, and fund individuals’ retirements. They all permit investors to trade a variety of securities, such as stocks, mutual funds, ETFs, and bonds. Different from other kinds of brokerage and investment accounts, IRAs most importantly offer account holders tax benefits. The main difference between traditional IRAs and Roth IRAs centers on the way taxes are paid or deferred by the IRS rules.

With a Roth IRA, owners pay taxes on contributions now. All gains that account holders make in the account then accrue tax free for the entire life of the retirement savings vehicle. The traditional forms of IRAs give holders the advantage of tax deferred contributions. This means that they will not have to pay any taxes on money contributed until they withdraw them later on at retirement time. All gains that they earn in the account over the life of the IRA will be taxable at the time they withdraw them.

With all of these types of IRAs, the annual contribution limits remain the same. For tax year 2016, this amount is $5,500 for individual contributions or $11,000 for married individuals filing jointly. Catch up contributions are also the same in these various kinds of IRAs. When people reach age 50, they can make additional contributions amounting to $1,000 each year for an individual or $2,000 for married people filing jointly.

This means that instead of adding $5,500 individually to the IRA for the year, an individual could contribute $6,500 per year once he or she turns 50. Similarly married individuals would be allowed to add $13,000 per year instead of $11,000 annually once they both reach age 50.

Traditional IRAs do not feature any income limits while Roth IRAs do have these. People can be disqualified from making investments in their Roth IRAs if they earn too much money any given tax year. Single filers are only allowed to make less than $110,000 each year. Above this income, the contribution amount which the IRS allows tapers down until the income reaches $125,000.

Once this income limit is reached, a Roth IRA contribution is disallowed for the tax year. With married filing jointly, the income maximum is higher. With under $173,000 earned for the year, the full $13,000 maximum contribution is permitted. This amount tapers off as the earnings rise to $183,000. Beyond these earnings, two individuals who are married are not allowed to utilize the Roth IRA in that particular tax year.

IRAs are different from 401(k)s, the other popular retirement savings vehicle, in several critical ways. Traditional and the other forms of IRAs can only be set up and maintained by an individual acting on his or her own behalf. 401(k)s are retirement accounts that employers set up on behalf of their employees. Many employers make partially matching contributions to their employees’ 401(k) accounts.

IRAs also commonly offer superior choices in different investment possibilities than do the more limited 401(k) plans. Self directed IRAs are allowed to invest in most any type of investment that is not considered to be a collectible item. This means that Self Directed IRAs are allowed to invest in franchises, real estate, precious metals, mortgages, energy, and other alternative investment ideas.

The term 'Traditional IRA' is included in the Investments edition of the Financial Dictionary. You can get your copy on amazon in Kindle or Paperback version. See more details here.