Traditional IRAs provide tax savings up front while tax-deferred growth. Withdrawals may become taxable upon retirement.
Dependent upon your income, contributions made may qualify for tax deduction. This may prove especially advantageous if you expect to enter retirement with lower tax brackets; early withdrawal penalties may apply as well.
Tax-deferred growth
An Individual Retirement Account, or IRA, can be an effective tool for saving for retirement with its tax-deferred growth potential. Consult a financial advisor in order to find the ideal investment strategy to reach your retirement savings goals.
Virtually anyone with earned income, such as wages, salaries, tips and other forms of taxable compensation such as bonuses can contribute to an Individual Retirement Account (IRA). Each year the IRS caps your IRA contributions but these limits are adjusted annually in response to inflation.
Traditional IRAs provide you with an upfront tax break by contributing funds to them, helping to reduce both current taxes owed and defer when taxes will need to be paid on future earnings. However, if your tax bracket will drop when retiring then Roth IRAs may be better.
Tax-deductible contributions
Traditional IRA contributions may be tax-deductible depending on income and whether or not both members of a household participate in workplace retirement plans, however there may be income thresholds which limit deductions, with those limits adjusted annually for inflation.
Traditional IRAs provide access to an array of investments, from stocks and bonds to mutual funds and hands-off investing solutions such as robo-advisors that use automated technology to match the investments with your goals and investment timeline – for a fraction of what a financial manager might charge.
IRS allows individuals to transfer funds from workplace retirement accounts into traditional IRAs with relative ease; however, be mindful of any tax repercussions such as taxes withheld from distribution or an early withdrawal penalty that could occur. A qualified financial planner can assist in this process as well as explain its advantages and drawbacks.
Minimum distributions
Traditional IRAs provide great savings potential, particularly for people without access to company retirement plans. However, this account requires taking required minimum distributions (RMDs) at certain ages, which will generally be taxed as ordinary income in that year; non-deductible contributions will also be subject to taxes upon withdrawal.
IRA accounts can be opened through banks, brokers, federally insured credit unions, savings and loan associations and mutual fund companies. You can invest in an IRA account using bonds, mutual funds and exchange-traded funds as investments with interest earning potential. Alternatively you may decide to opt for self-directed IRA (SDIRA). With either option you are free to make your own investing decisions – the choice is yours!
Anyone with earned income can open an IRA, although your ability to deduct contributions may decrease with rising income levels. If your workplace offers retirement plan coverage, contributions can be made via payroll deduction or via a Simplified Employee Pension (SEP) or Savings Incentive Match Plan for Employees (SIMPLE) IRA setup by your employer.
Penalties for early withdrawals
IRAs can be an excellent way to save for retirement, but there are certain rules surrounding early withdrawals. Withdrawals before age 59 1/2 usually incur a 10% penalty in addition to ordinary income taxes; however, there may be exceptions.
As an example, you can withdraw IRA money without penalty in order to cover medical expenses exceeding 7.5% of your adjusted gross income, birth or adoption expenses and disaster relief needs. Furthermore, funds from an IRA may also be withdrawn to finance first home purchase purchases as well as qualified disability expenses or funeral costs related to an IRA owner passing away.
Traditional IRAs provide a viable retirement savings solution for individuals without access to workplace retirement plans like 401(k) or 403(b). They may even be used to roll over an account from another workplace account. Self-employed and small business owners can save even more through SEP or SIMPLE IRAs.
