Table of Contents
- Traditional IRA – One of Many Retirement Account Options
- What is a Traditional IRA?
- How Does the Traditional IRA Work?
- 2023 Traditional IRA Contribution Limits
- What Are the 2023 Income (Phase-Out) Limits for Traditional IRA Contributions?
- What Do You Do If Your Income Exceeds the Phase-Out Range?
- What Are the Benefits of a Traditional IRA?
- Rollover IRA vs. Traditional IRA
- Is a Traditional IRA a Good Investment?
A traditional IRA offers investors retirement savings growth with tax benefits and easy withdrawals during retirement.
A traditional IRA is not a one-size-fits-all retirement account, however. Traditional IRA withdrawals are taxed at the time they are made (and there may be penalties for withdrawals made prior to age 59½). There are also income limits to the tax deductions.
Here’s what you need to know about traditional IRAs, according to the IRS.
Traditional IRA – One of Many Retirement Account Options
There are dozens of ways you can invest your money and each opportunity offers unique benefits. First, you must define your investment goals.
When planning for retirement, focus on investments that offer tax benefits. These usually fall into two main categories:
- Employer-sponsored retirement plans, such as a 401(k) or the Thrift Savings Plan
- Individual plans, such as an IRA
For many investors, an individual retirement arrangement (IRA) is the ideal way to save toward retirement and earn the most from their investments. You can contribute to an IRA alone or in conjunction with other retirement accounts.
Within the world of IRAs, there are several options, including the Roth IRA and several IRAs designed for self-employed individuals and those working for small companies.
We’ll look specifically at the traditional IRA and who benefits most from this type of retirement account.
What is a Traditional IRA?
A traditional IRA is a savings plan that allows contributors to use pre-tax dollars to invest in stocks, bonds, CDs, mutual funds and other investment vehicles.
It’s a popular savings tool for individuals who may not have access to employer-sponsored retirement plans, or for those who want to have an additional retirement account that offers tax-deferred growth on investments.
How Does the Traditional IRA Work?
You must be under the age of 70½ to open a traditional IRA, and make contributions from taxable compensation.
You can open a traditional IRA at your local bank, a brokerage company or a mutual fund company.
The HEROES Act allows deployed military members to contribute to an IRA with tax-free combat pay.
2023 Traditional IRA Contribution Limits
The maximum contribution limit for a traditional IRA is $6,500 in 2023, unless you are at least 50 years old. If you’re at least 50, you can make an additional $1,000 catch-up contribution, according to the IRS.
Traditional IRAs share the same contribution limit as the Roth IRA. You can contribute $6,000 ($7,000 with catch-up contributions) between both accounts. This means you can contribute the full amount to a traditional IRA or a Roth IRA, or you could contribute $3,000 to each account or any combination that does not exceed the total annual contribution limit.
What Are the 2023 Income (Phase-Out) Limits for Traditional IRA Contributions?
Owners of a traditional IRA may deduct contributions when filing their income taxes, as long as they fall within IRS income thresholds. This lowers your taxable income in the current year, which is a nice benefit.
If your modified adjusted gross income (MAGI) exceeds the amount allowable by the IRS, your contributions may qualify for a partial deduction. If your income exceeds the allowable MAGI, you can not deduct your traditional IRA contributions.
These income limits are commonly referred to as the phase-out range, and for 2023, the following limits are in place:
- $73,000 – $83,000 for those filing single or head of household
- $116,000 – $136,000 for married couples filing jointly
If you earn income below the lower limit, can deduct the full amount of your IRA contributions from your taxes.
If your income falls within the above ranges, you can deduct a partial amount of your contributions. If your income exceeds these limits, you can not deduct any of your IRA contributions.
The following table shows the full traditional IRA tax deduction phase-out income ranges.
| Filing Status | Modified AGI | Deduction |
|---|---|---|
| Single or head of household | $73,000 or less | Full deduction up to the amount of your contribution limit |
| More than $73,000 but less than $83,000 | Partial deduction | |
| $83,000 or more | No deduction. | |
| Married filing jointly or qualifying widow(er) | $116,000 or less | Full deduction up to the amount of your contribution limit |
| More than $116,000 but less than $136,000 | Partial deduction | |
| $136,000 or more | No deduction | |
| Married filing separately | Less than $10,000 | Partial deduction |
| $10,000 or more | No deduction | |
| If you file separately and did not live with your spouse at any time during the year, your IRA deduction is determined under the "Single" filing status. | ||
What Do You Do If Your Income Exceeds the Phase-Out Range?
You can still contribute to a traditional IRA if your income exceeds the limits for tax deductible contributions. However, you must contribute to a non-deductible IRA or a Roth IRA, which has different rules.
You can make Roth IRA contributions with money that has already been taxed. The money grows, and you can deduct it tax-free when you retire, as long as you meet IRS withdrawal requirements.
However, Roth IRAs also have income limits, which you must consider.
If you exceed both the deductible traditional IRA and the Roth IRA income limits, consider contributing to a non-deductible traditional IRA. This still allows you to contribute to an IRA, even though you don’t get the tax deduction when you file your return.
You can always convert your traditional IRA to a Roth IRA at a later date. I recommend reading up on this, as it may cause a taxable event. Consult with a tax professional or a fee-only financial planner for more information.
What Are the Benefits of a Traditional IRA?
When contributions qualify as a tax deduction, owners of a traditional IRA can benefit by lowering their taxable income when they file their federal tax return. This allows for tax-deferred growth on contributions and earnings throughout the lifetime of the IRA.
However, the government will tax traditional IRA money when you withdraw it.
And if you withdraw money before you’re 59½ years old, you must pay a 10% early withdrawal penalty.
Contributions to a traditional IRA must cease when the account owner reaches age 72, at which time required minimum distributions (RMDs) begin. Failure to take required mandatory distributions incurs a 50% IRS penalty, which applies to the required withdrawal amount.
Rollover IRA vs. Traditional IRA
If you have a 401(k), 403(b) or a previous employer-sponsored retirement account, you can roll those funds into an IRA. This may be helpful if you are between jobs or you want to consolidate multiple retirement accounts into one place.
Like a traditional IRA, a rollover IRA lets you preserve the tax-deferred status of your retirement assets, and you don’t pay early withdrawal penalties or taxes when you make the transfer.
Instead, you’ll pay taxes on it when you withdraw the funds, according to whichever income tax bracket you fall under in retirement.
Annual contribution limits do not apply to the rolled-over amount, but any contributions you make outside of the rollover are subject to the $6,000 contribution limit. If you’re over 50 years old, you can contribute an extra $1,000 catch-up contribution.
If you don’t make any additional contributions, you can reverse the rollover and put your funds in a future employer’s retirement plan later.
Depending on your investment goals and risk tolerance, you can roll your old account into several possible IRA options, including stocks, bonds and mutual funds. However, there may be tax implications if you roll company stock into an IRA.
Per current IRS regulations, your former employer may complete your request through a direct or indirect rollover of your retirement account funds.
With a direct rollover, your plan administrator delivers your distribution to the IRA provider. You don’t take possession of your funds, so you don’t have to pay taxes on them.
Some employers may complete the process with an indirect rollover. In this case, you would receive some or all the funds from your retirement account to place into another eligible plan within 60 days.
Your employer may withhold 20% of the funds for federal income tax, but you can recover this deduction in the form of a tax credit when you file your tax return and deposit it into the rollover IRA later.
Is a Traditional IRA a Good Investment?
A traditional IRA can be a great investment vehicle for individuals who understand the rules and fall within income-eligibility requirements. For many, the immediate tax benefits associated with the traditional IRA make this type of account attractive.
If you anticipate being in a lower tax bracket at the time of distribution, the traditional IRA may be the right account for you.
For more information about IRAs, see:
- Comparing Traditional and Roth IRAs.
- Why Military Members Should Open Roth IRAs.
- IRS Publication 590, Individual Retirement Arrangements (IRAs).
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