What Is a Traditional IRA?

Are you looking for a way to save for retirement while reducing your tax bill? Then you might want to consider a traditional IRA. You generally don’t pay taxes on the money you put into a traditional IRA until you take it out in retirement.

It’s called an “individual” retirement account (IRA) because you, as an individual, set up and manage it on your own. It’s not something your employer handles for you, like a work-related retirement plan. 

But what exactly is a traditional IRA, and how does it work? Let’s find out.

In this article, we’ll cover:

• What a traditional IRA is
• How traditional IRAs work
• Traditional IRAs vs other IRAs
• Pros and cons of traditional IRAs
• How to open a traditional IRA account

What is a traditional IRA?

Traditional IRA definition: A traditional IRA is a type of retirement account that offers tax advantages. When you contribute money, you’re often able to deduct that amount from your income taxes. This helps to lower your taxable income for the year.

A traditional IRA is a type of retirement account that offers tax advantages. When you contribute money, you’re often able to deduct that amount from your income taxes. This helps to lower your taxable income for the year.

For example, if you earn $50,000 a year and contribute $7,000 to a traditional IRA, your taxable income would be $43,000. This can potentially save you money on your tax bill.

A traditional IRA is best if:

• You want to lower your taxable income now
• You expect to be in a lower tax bracket in retirement

How traditional IRAs work

Anyone with earned income can contribute to a traditional IRA—there are no income restrictions. You can open a traditional IRA with Stash, your bank, or any other brokerage firm. 

When you put money into a traditional IRA, it’s not just sitting there idly. You get to decide how to invest it. You can invest IRA funds in various ways, like stocks, bonds, exchange-traded funds (ETFs), and other securities. 

The money inside a traditional IRA grows tax-deferred. This means you won’t pay taxes on it until you withdraw the money in retirement. Over the long term, this tax-deferred growth can help you build wealth.

Contribution limits

The annual contribution limit to a traditional IRA is $7,000 as of 2024. If you’re 50 or older, you may make an additional $1,000 catch-up contribution, for a total of $8,000 annually.

There are two caveats, though:

1. If you earn less than the current year contribution limit, you can only contribute up to the total of your earned income for the year. So if your earned income is $3,000, your cap is $3,000.
2. This limit applies to traditional and Roth IRAs combined. So if you have both accounts, your total contribution cannot go over this limit.

Tax deduction

Traditional IRA contributions are typically made with pre-tax dollars, so you can get an immediate tax benefit by deducting them from your taxable income for the year. Doing so might put you in a lower tax bracket or make you eligible for certain tax incentives.

If you don’t have an employer-sponsored retirement plan, like a 401(k) or 403(b), you can deduct the entire amount you’ve contributed for the year. However, if you or your spouse participate in an employer plan, you might not be able to deduct the full amount. 

The IRS sets deduction limits based on your filing status and modified adjusted gross income (MAGI). If you’re single and have a workplace plan, your MAGI must be below $87,000 to receive at least a partial deduction. If you’re married and filing jointly, you must earn less than $143,000. This income limit applies even if your spouse has a workplace plan, but you don’t.

Age limits

Before 2020, you couldn’t contribute to a traditional IRA past age 70½. But now, there is no age limit. Anyone with earned income can contribute to a traditional IRA. This change was due to the SECURE Act, which went into effect on January 1, 2020. 

Early withdrawal rules

Generally, you can start taking funds out of your traditional IRA when you turn 59½, and you’ll pay regular income tax when you make withdrawals. 

If you take out money early, however, you’ll usually have to pay a 10% penalty on top of income tax. There are a few exceptions to the IRA early withdrawal rule, including:

• Becoming totally and permanently disabled
• Paying for certain higher education expenses
• Buying your first home, up to $10,000
• Paying health insurance premiums while unemployed
• Taking substantially equal periodic payments (SEPPs) for at least five years or until you turn 59½, whichever comes later

Check out IRS Publication 590-B for important information on these and other exceptions.

Required minimum distributions (RMDs)

Once you reach a certain age, you’re required to start taking withdrawals from your traditional IRA each year. This age has gradually increased through various legislation over the past four years. Currently, if you reach age 72 after Dec. 31, 2022, then you must start making withdrawals at age 73.  These withdrawals are called required minimum distributions (RMDs), and they’re based on your life expectancy and IRA account balance.

If you don’t take RMDs, you could pay a hefty excise tax of up to 50% of the amount you were supposed to withdraw. So make sure you plan ahead and take your RMDs on time.

Pros and cons of contributing to a traditional IRA

Traditional IRA benefits

An IRA of any kind can help you put away money for retirement and possibly enjoy tax advantages. The particular benefits of the traditional IRA include:

• Your tax-deductible contributions can lower your taxable income for the year, and may even drop you into a lower tax bracket. 
• You pay no taxes on funds while they’re invested, meaning there’s more money in the account to compound over time.
• If you’re in a lower tax bracket when you make withdrawals than when you made contributions, you may pay less tax on your money overall.  
• You can invest in the stock market through a wide variety of securities, including stocks, mutual funds, and ETFs.
• There’s no income limit; you can put money into a traditional IRA no matter how much you make. 
• Some exceptions allow you to avoid the early distribution penalty. 

Disadvantages of traditional IRAs

Depending on your circumstances, there may be some downsides to a traditional IRA compared to other types of IRAs, including:

• Withdrawing before you reach 59½ years of age may result in a 10% penalty
• There are yearly limits on how much you can contribute
• You must take required minimum distributions after age 73
• Possible limits on tax deductions if you or your spouse have an employer-sponsored retirement plan

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How traditional IRAs differ from other IRAs

There are several different types of IRAs, both for individuals and employees. The terms of each differ based on eligibility, contribution limit, income limit, tax treatment, and a few other factors. The comparison chart below reflects information as of 2024 for four common types of IRAs.

Key differences	Traditional IRA	Roth IRA	SIMPLE IRA	SEP IRA
Who’s it for	Individuals	Individuals	Employees	Employees/Individual
Eligibility	No age limit, must earn at least contribution amount	No age limit, must earn at least contribution amount	No age limit, employer can’t have other retirement plan	Must be 21+ Must have worked for business 3 of last 5 years Minimum $750 in yearly compensation
Income limit	None	$161,000 if single; $240,000 if married	None	None
Contributions	Pre-tax money	After-tax money	Pre-tax money	Pre-tax money
Contribution limits	$7,000/year	$7,000/year	$16,000/year	$69,000/year or 25% of compensation up to $345,000 (whichever is less)
Catch-up contributions	$1,000/year if 50+	$1,000/year if 50+	$3,500/year if 50+	None
Taxes on Qualified withdrawals	Taxed as ordinary income	Tax-free	Taxed as ordinary income	Taxed as ordinary income

Roth IRA

A Roth IRA is similar to a traditional IRA in many ways: it’s an individual retirement account that offers tax advantages as long as you leave your money in it until you turn 59½. The main difference between a traditional and a Roth IRA is when the money is taxed. When you start a Roth IRA, you pay income tax on money before you invest it. Then, when you make qualified withdrawals, you don’t pay any income tax at all, including on the money your account has earned. You’re also allowed to withdraw funds you’ve contributed at any time without penalty, though you’ll be subject to a 10% penalty if you withdraw earnings early.

A Roth IRA is best if:

• You want tax-free income in retirement
• You believe your tax rate will be higher in the future

SIMPLE IRA

The Savings Incentive Match Plan for Employees, or SIMPLE IRA, allows an employer to set up traditional IRAs for their employees; both the employer and employee can make contributions. It’s generally available for small businesses with fewer than 100 employees that don’t have another retirement savings plan, like a 401(k). If your employer offers a SIMPLE IRA, they’re required to contribute a certain amount each year, but you don’t have to put in any money. 

A SIMPLE IRA is best if:

• You’re a small business owner or work for a small business and want an uncomplicated way to save for retirement.

SEP IRA

The Simplified Employee Pension Plan, or SEP IRA, is a retirement account that can be established by either an employer or a self-employed person. Unlike the SIMPLE IRA, only an employer can contribute to a SEP IRA. The employer is allowed to take a tax deduction for contributions made, and they must contribute equally to all eligible employees. Note: if you’re self-employed, you are considered the employer, so you can make contributions and take tax deductions.  

A SEP IRA is best if:

• You’re self-employed or own a small business and want a simplified way to save for retirement while potentially contributing more than traditional IRA limits.

Rollover IRAs

If you have an employer-sponsored retirement plan and leave your job, you can usually do what’s called a rollover, in which you transfer the funds from your retirement plan into an IRA. Most people are eligible to roll over funds into either a traditional or Roth IRA, but there can be tax implications if you’re rolling over pre-tax (traditional) money into a Roth IRA. If you’re trying to decide what to do with your 401(k) or 403(b), you may want to brush up on the IRS rules for rollovers. 

A rollover IRA is best if:

• You’re leaving a job and want to consolidate your retirement savings from an employer-sponsored plan.

How to open a traditional IRA account

To get started with your very own IRA, follow these key steps:

Pick the right IRA provider

The first step to opening a traditional IRA is to pick a reliable provider. Research different options, like banks, online brokers, or Stash IRAs. Choose a provider that suits your investment needs and preferences.

Open your account

Once you’ve chosen a provider, complete the online application process to open the account. This usually takes 15 to 20 minutes, during which, you’ll be asked to give your name, address, and Social Security number to verify your identity.

Choose your contribution amount

Decide how much money you want to put into your IRA each year. The maximum contribution limit for 2024 is $7,000 or $8,000 if you’re at least 50. Remember, you’ll also be limited by your amount of earned income.

Select your investments

In a traditional IRA, you can invest in a variety of assets like stocks, bonds, mutual funds, and exchange-traded funds (ETFs). Research and choose investments that suit your risk tolerance and financial goals. Stash has automatic investing tools to help you build wealth regularly. 

Monitor and adjust

Review your account’s performance and make adjustments as needed. This might mean rebalancing your investments or changing your contribution amounts. 

Use a retirement calculator to determine how much you’ll need to save for retirement based on your age and desired retirement income. This will help you set a realistic savings goal and plan for a comfortable retirement.

Is a traditional IRA right for you? 

The sooner you start investing for the future, the more time your money has to grow. When you’re deciding whether a traditional IRA is the right choice for you, you might consider things like:

• Flexibility: Are you able to leave your funds in your account until retirement age to avoid incurring penalties? 
• Tax deductions: Do you want to lower your tax bill now or pay less tax in the future?
• Income limits: Do you have a higher income level that might disqualify you from opening a Roth IRA?

When it comes to tax-advantaged individual retirement accounts, people are often weighing the pros and cons of a traditional IRA vs. a Roth IRA. Good news: you can have both.

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Frequently asked questions

1. What are the annual contribution limits for a traditional IRA?

In 2024, the maximum you can contribute is $7,000 or $8,000 if you’re 50 years or older. It’s essential to stick to these limits; there may be penalties if you go over them.

2. What happens if I contribute more than the annual limit to a traditional IRA?

If you contribute more than the annual limit to a traditional IRA, you might face a penalty of 6% on the excess amount every year until it’s corrected. This penalty can add up quickly, so if you accidentally over-contribute, correct it as soon as possible.

3. Can I have both a traditional IRA and a 401(k) plan?

Yes, you can contribute to both a traditional IRA and a 401(k) in the same year. However, your ability to deduct your traditional IRA contributions from your taxable income may be limited if you or your spouse is covered by a workplace retirement plan.

4. Should you contribute to a traditional IRA if it’s not tax-deductible?

Even if you can’t deduct your IRA contributions from your tax return, it might still be worth it to contribute. The primary reason is that you can still grow potential earnings tax deferred. But if you’re looking for alternatives, consider opening a Roth IRA or increasing contributions to your 401(k), especially if you have access to an employer match. 

5. What happens to a traditional IRA when you die?

Your traditional IRA will pass to your designated beneficiaries when you die. They will have the option to take account distributions over their lifetime or as a lump sum. If you don’t designate a beneficiary, your traditional IRA will go through probate, which can be a lengthy and expensive process.

6. Who cannot open a traditional IRA?

Individuals who don’t have earned income, like wages, salaries, or self-employment income, cannot open a traditional IRA. One exception is if you’re married and your spouse works. In this case, your spouse can contribute to a traditional IRA on your behalf when you file a joint tax return. This is known as a spousal IRA contribution.