Traditional IRA | Definition, Rules & Options

What is a traditional IRA?

A traditional IRA is an individual retirement account in which investments grow tax-deferred and contributions can be tax-deductible.

How does a traditional IRA work?

• You open a traditional IRA at a brokerage or bank. Then you select what you want to invest in, such as mutual funds, stocks, bonds, exchange-traded funds (ETFs) or bank savings products. (For a long-term goal like retirement, we recommend investing in stocks and bonds because of their higher returns. That means opening your traditional IRA at a brokerage or robo-advisor rather than at a bank.)

• You invest what's in the account. Like a traditional IRA, a Roth IRA is an account that holds your investments, rather than an investment itself. What your Roth IRA earns and whether you lose money depends on how you invest. Here's more on how to invest your IRA.

• The investments grow tax-deferred. You're not taxed on gains until you withdraw them. Early withdrawals may be taxed as income and assessed a 10% penalty.

• You can add money to a traditional IRA over time. You can contribute a lump sum or make smaller contributions throughout the year, as long as your contributions don't exceed the annual limit (see below). You can also add to your IRA by rolling over money from another retirement account. You can save in an IRA even if you have a workplace plan, such as a 401(k).

• You might be able to deduct your traditional IRA contributions on your taxes. For example, if your income is $60,000 and you contribute $6,000 to a traditional IRA, then your taxable income that year will drop to $54,000, assuming you qualify for the tax deduction (more on that below).

• Traditional IRAs aren't the same as Roth IRAs. With Roth IRAs there’s no tax deduction when you make contributions, but your withdrawals come out tax-free in retirement. You never pay taxes on your investment earnings, as long as you follow the Roth IRA rules.

» Compare Roth IRAs vs. traditional IRAs

What are the benefits and advantages of a traditional IRA?

These accounts have more benefits than drawbacks. Here are some of the pros and cons:

Qualifying for a traditional IRA when you have a 401(k) or other employer plans

The good news: Everyone can open and contribute to a traditional IRA.

The bad news: Not everyone is eligible to deduct their contributions to a traditional IRA.

• If you or your spouse has a retirement plan at work, the amount of your traditional IRA contribution that you can deduct is reduced, or eliminated altogether, once you hit a certain income. You can still make contributions, but they won’t be tax-deductible.

• If you, and your spouse if you're married, don't have retirement plans at work, then you can deduct your IRA contribution no matter how much your income.

Note: The income limits apply to your modified adjusted gross income (MAGI), which is your adjusted gross income with some deductions and exclusions added back in. See IRS Publication 590-A, Worksheet 1-1, for complete instructions on figuring MAGI for traditional IRAs.

Traditional IRA income limits in 2019 and 2020

These income limits apply only if you (or your spouse) have a retirement plan at work.

Traditional IRA distributions and withdrawals

Here's the basic overview:

• Generally, you can start taking distributions from a traditional IRA when you reach age 59 1/2.

• You pay regular income tax on distributions from your Traditional IRA. (See what tax bracket you're in.)

• If you take money out of your traditional IRA before age 59 1/2, you may have to pay a 10% early withdrawal penalty. There are some exceptions to this early withdrawal penalty, such as needing the money for college, buying a house or other reasons.

• You don't have to start taking distributions from your traditional IRA just because you reached your 59 1/2 birthday. You can wait. However, you can't wait forever; you must start taking required minimum distributions (RMDs) when you reach age 70 1/2 or 72, depending on your birthday.

Where can I open a traditional IRA?

Many financial services companies offer traditional IRAs, including online brokers and robo-advisors.

• If you want to select your own investments for your IRA, an online broker is likely a good home for your account. With a broker, you’ll select from investments accessible through that provider, including stocks, bonds and mutual funds. (Remember, a traditional IRA isn’t an investment itself, but an account that holds investments.)

• If choosing your own investments sounds too daunting, consider a robo-advisor. These providers, which now include many of the most recognizable names in investing, use automated technology to choose investments based on your goals and investing horizon, all for a fraction of what a traditional investment manager might charge.

• Many banks also offer IRAs, but usually the investment choices at a bank are limited to certificates of deposit. For a long-term goal like retirement, we generally suggest a diversified mix of stocks and bonds, because that mix historically has offered a much higher rate of return.

Here are some of NerdWallet’s top picks for IRA accounts:

» See our full roundup of the best IRA providers

Should I contribute to a traditional IRA if I can’t deduct it?

Nondeductible IRA contributions can still be valuable: Money saved for retirement is money saved for retirement, and your investment earnings will still grow tax-deferred. But this can also be a headache: You are responsible for keeping track of after-tax contributions by filing IRS Form 8606 each year so you’re not taxed again on that money when you take retirement distributions.

In short, there are better options you should max out before going down the nondeductible IRA road. They are:

1. A Roth IRA, if you’re eligible. These accounts have income eligibility rules, but they are higher than the limits to deduct traditional IRA contributions. See our IRA limits page for the 2020 and 2019 limits on both account types.

2. Your employer-sponsored retirement plan. Max that account out before making nondeductible IRA contributions. Doing so may actually enable you to be eligible for an IRA deduction because your contributions to the workplace plan lower your taxable income for the year.

If after exhausting both of those options, you still want to consider the nondeductible route, see our page on nondeductible IRAs.

Other types of IRAs