Traditional IRA
An individual retirement account, opened on one’s own, where contributions may be tax-deductible and investments grow tax-deferred until withdrawal.
What it means
A traditional individual retirement account (IRA) is opened directly at a bank or brokerage rather than through an employer. Anyone with earned income can contribute up to a limit the IRS sets each year, and a nonworking spouse can contribute based on the working spouse’s income.
Contributions are fully deductible for people not covered by a workplace plan. If someone or their spouse is covered, the deduction phases out above income ranges the IRS sets each year, though nondeductible contributions are still allowed. Withdrawals are taxed as ordinary income, most withdrawals before 59½ face a 10% additional tax, and required minimum distributions begin at an age set by federal law.
Example
Suppose someone in a hypothetical 22% bracket deducts a $5,000 contribution. Their federal income tax falls by $1,100 this year, and the $5,000 grows untaxed until it is withdrawn.
How it’s used
- Saving when no workplace plan is available
- Adding to savings beyond a 401(k)
- Receiving rollovers from old employer plans
Strengths and weaknesses
Strengths
- Wide choice of investments at most brokerages
- Possible tax deduction lowers current income tax
- Tax-deferred growth
- Useful home for rollovers from employer plans
Weaknesses
- Annual limit is much lower than a 401(k)’s
- Deduction may be reduced or lost when covered by a workplace plan
- Required minimum distributions later in life
- Withdrawals are taxed as ordinary income
Good to know
- Keep records of any nondeductible contributions so that part is not taxed twice when withdrawn.
Related terms
Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.