The Traditional Individual Retirement Account (IRA) has been the chosen retirement plan for generations of investors and is heralded as the propagator of the American dream by providing safe, continued benefits for people, at the time they need it the most ie; post retirement. The Traditional IRA is a retirement account plan in which a part of the pre-tax income is channelized into a savings account for tax-deferred earnings growth via chosen investment vehicles. There is no tax on the earnings growth via capital gains or dividend income thereby ensuring faster growth of the earnings.
The individuals participating in traditional IRA get immediate Tax-benefits if their contributions fall in the tax-deductible category. Yet the time proven strategy for getting the most out of the Traditional IRA is same as that applies to any other Retirement account, to get in early in life and to ensure the funds stay untouched till the stipulated distribution period is reached. This ensures the earnings from the IRA is maximized as the purpose of the retirement account is to fund the post-retirement financial needs and it is not to be used as an answer to temporary financial emergencies.
The deductible IRA is funded with pre-tax dollars and the contributions have tax-deductible elements for the qualified individuals. Thus, the qualified individuals earn tax benefits with the deductible IRA which makes it a lucrative option for most of the wage earners.
The eligibility parameter for contributions to fund a Traditional IRA is that the individual (or either one of the spouse-in case of the married couples) under the age of 70.5 years have earned income. The deadline to fund the IRA is by April 15th of the next Financial year.
The Traditional IRA doesn’t have income limits for contributions, which means, anyone with an earned income is eligible to make contributions which is limited to $5,500 for people under the age of 60 and $6,500 for the individuals over the age of 60. To get the maximum tax deduction, your income needs to be below $60,000 for singles and $181,000 for married couples filing jointly. See IRS limits on deductions for detailed deduction criteria
Early Withdrawals and Penalties
Early Withdrawals & Penalties
Since the Traditional IRA is a tax-deferred plan, the individuals are not taxed for earnings growth on the investments till they make withdrawals from the account. There are penalties for early withdrawals, i.e. withdrawal prior to the retirement age (59 and under) which may incur up to 10% penalty from the government and may even levy additional taxes by the State.
The withdrawals are penalty free between the age of 59 and half years of age and 70 and half years of age, however, the earnings in the account would be taxed as ordinary income. There is a mandatory distribution clause for Traditional IRAs wherein at reaching the age of 70.5 years, the individual must take a Required Minimum Distribution (RMD) from the IRA savings. There are special clauses and allowances to avoid penalties as incase of Disability or Death, Loan for First-time home buyers, Educational expenses, Health insurance and other special categories listed on the IRS website.
Pros and Cons
Pros and Cons
Traditional IRAs benefits include participation for all earning individuals.The contributions are tax- deductible to the dollar mount for qualified individuals hence immediate tax-benefits make a lucrative value proposition. The Traditional IRA have protection for the contributions against creditors in case of bankruptcy.
The disadvantages for Traditional IRAs are related to the constraints put in terms of maximum age for contributions being limited to 70 and half years and the mandatory withdrawal norms under RMD failing which there is a possibility to incur penalties.
The Traditional IRA has been the chosen plan for generations due to its flexibility in terms of participation and tax-benefits gain. However, with the advent of Roth IRA, the benefits of Traditional IRA are tad overshadowed by the newer version with diverse flexibilities. The future begets well for both plans as the Traditional IRA has a loyal base of participants who swear by the virtues of time-tested attributes and applicability.