What is a Traditional IRA?

What is a Traditional IRA?

by Donn J. Sinclair MBA   March 5, 2020

A Traditional IRA is an Individual Retirement Account that permits you to set aside funds in a tax-favored retirement savings/investment program.  One of the two most important IRA advantages is that you may be able to fully or partially deduct your contributions from your current tax year federal and state taxable income.  If so, then your IRA contribution should reduce your current tax year federal and state taxes.  This should leave you more money in your Traditional IRA account to earn you more money in the years ahead !

The second important Traditional IRA advantage is that generally any IRA earnings, gains, and or interest inside your IRA are not taxable until you redeem funds from your IRA.  Once again, these potential IRA earnings represent more money in your IRA that might earn you more money in the years ahead.  

Remember that the Traditional IRA purpose is to allow you to save money for your retirement years.  In retirement many people have lower or no net taxable income.  So IRA money redeemed in retirement may be at lower tax rates, and potentially with no taxes due at all.

So far we have focused on the tax deductible Traditional IRA contribution.  Nondeductible IRA contributions can also be made into your Traditional IRA.  These nondeductible contributions are not deducted from your current tax year income for federal or state income tax purposes.  Thus these nondeductible IRA contributions should not directly reduce your current tax year income taxes.

The tax advantage to a nondeductible IRA contribution is that these nondeductible contributions can grow tax-deferred inside your Traditional IRA.  Tax-deferred of course meaning that no taxes are due on any interest, earnings or gains inside your nondeductible IRA.  If you make any nondeductible IRA contributions, then it may be best to open a separate Traditional IRA account for only your nondeductible IRA contributions.    

Now is a great time to discuss with your tax advisor whether you qualify for a fully or partially deductible Traditional IRA contribution.  Your household income, whether you or your spouse have access to an employer sponsored retirement account, help determine whether you qualify for a fully or partially Traditional IRA deductible contribution.  Employer sponsored retirement accounts include 401k plans, 457 plans, and 403b plans.  

Please note that your Traditional IRA is intended to be a long-term savings and or investment program for your retirement years.  Generally  prior to your age 59.5 there is a potential 10% penalty for funds redeemed from your IRA.  Please consult IRS.gov or your tax advisor for more information.

 

Donn J. Sinclair, MBA   (803)329-0609

Updated in Charlotte NC and Rock Hill SC  

March 5, 2020

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