What is a Traditional IRA ?

What is a Traditional IRA ?

by Kristin Sinclair  – March 22, 2019

An Individual Retirement Account (IRA) is a tax-favored savings or investment vehicle that you establish with a financial institution, or quite often with the help of a financial professional. The Traditional IRA, often referred to as the Original IRA, is one of the most popular IRAs. Normally you make a deductible contribution for the current tax year into your Traditional IRA. When you make a deductible contribution, that amount is deducted from your taxable income federal income tax purposes. This means you normally do not pay current income taxes on your deductible contributions, and only pay taxes later when you make withdrawals from your Traditional IRA. Thus, your deductible contribution becomes tax-deferred income. By deferring taxes, any dividends, interest payments, and capital gains can compound each year without being reduced by current taxes. Thus the Traditional IRA has the opportunity to grow much faster than a taxable account. Often retirees find themselves in a lower tax bracket than during their pre-retirement working years. Then the Traditional IRA funds should be withdrawn and taxed at a lower rate.

 

So far we have focused on the deductible Traditional IRA contribution. Nondeductible contributions can also be made into Traditional IRAs. These nondeductible contributions are not deducted from your current income for federal income tax purposes. They should not directly reduce your current income taxes; however, these nondeductible contributions can grow tax-deferred inside your Traditional IRA. Your household income, whether you or your spouse have access to an employer sponsored retirement account, help determine whether you qualify for a full or partial Traditional IRA deductible contribution. Employer sponsored retirement accounts include 401k plans, 457 plans, and 403b plans. Now is a great time to discuss with your tax advisor whether you qualify for a full or partial deductible contribution. Please also discuss the importance of keeping deductible and nondeductible contributions in separate Traditional IRAs.

 

The Traditional IRA has promising advantages for those qualified:

  • Depending on your circumstances, you may be able to deduct some or all of your IRA contributions from current income. Deductible contribution limits are $6,000, and $7,000 for those 50 and older.
  • Funds in your IRA, including earnings and gains, are normally not taxed until they are distributed.

 

Example:

Stephanie works in Charlotte NC and participates in her employer’s 401k retirement plan. She is single and her adjusted gross income should be less than $50,000 for 2019. Her tax advisor tells Stephanie that she should qualify for the full $6,000 Traditional IRA 2019 deductible contribution. Her tax advisor also recommends that Stephanie make that 2019 contribution as early as possible. This should change any future earnings from current taxation to tax-deferred.

 

Stephanie is engaged to Michael, and they plan to marry in June 2020. He is covered by a retirement plan at his Winthrop University position in Rock Hill SC. Michael has a much higher adjusted gross income than Stephanie. Their 2020 combined income after their upcoming nuptials may reduce or eliminate any future deductible Traditional IRA contributions. Once again, a discussion to have with their tax advisor.

 

Updated by Kristin P. Sinclair   (803)329-0615

in Rock Hill SC and Charlotte NC   March 22, 2019

KPS: More details and information are available at IRS.gov.

See Publication 590-A and Publication 590-B.

 

 

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