A traditional IRA is an individual retirement account that offers tax advantages to savers. If you contribute to one of these accounts, you not only get to build a much-needed pot of money for retirement, you also get tax perks from the IRS for doing so.
In 2017, the IRA contribution limit is $5,500, or $6,500 if you’re 50 or older.
The traditional IRA tax advantage
It’s not coy to say that the tax treatment of a traditional IRA is, well, traditional. This is the straight-up, plain-vanilla version of an IRA — no twists, no funny business when it comes to taxes:
- Traditional IRA contributions are deductible in the year they are made
- The IRS gets its share when you take retirement distributions, which are taxed as ordinary income
- In the meantime, you get the benefit of tax-deferred investment growth
If you believe your tax rate will go down in retirement — which is often the case for those further along in their careers or at a salary peak — you can save with a traditional IRA by putting off paying taxes until you qualify for the lower rate.
The other kind of tax treatment comes in the form of a Roth IRA, the traditional IRA’s cousin. These accounts reverse the tax benefit of a traditional IRA: There’s no tax deduction when you make contributions, but distributions in retirement are not taxed. That turns tax-deferred growth into tax-free growth, and it’s likely a better choice if you expect your tax rate to go up in retirement rather than down.
» MORE: Read our Roth vs. traditional IRA comparison.
Traditional IRA pro and cons
These accounts have far more benefits than drawbacks. Still, it’s important to note the strengths and weaknesses when comparing traditional IRAs to other savings vehicles:
Traditional IRA deduction rules
Everyone is eligible for a traditional IRA. But you may not be able to deduct your contributions if you or your spouse is covered by an employer retirement plan, like a 401(k), and your income passes a certain threshold.
The IRS doesn’t want you to squeeze too much out of the system, so as income climbs, the amount of your traditional IRA contribution that you can deduct is reduced, then eliminated altogether. To be clear, you can still make contributions, but they won’t be tax-deductible.
Traditional IRA deduction limits for 2017
|Filing status||2017 modified AGI||Tax deduction|
|Married filing jointly or qualifying widow or widower||Full deduction up to contribution limit|
|Single or head of household||$62,000 or less||Full deduction up to contribution limit|
|More than $62,000 but less than $72,000||Partial deduction|
|$72,000 or more||No deduction|
|Married filing separately||If you or your spouse is covered by a workplace retirement plan: Less than $10,000||Partial deduction|
|If you or your spouse is covered: $10,000 or more||No deduction|
If you fall into the phase-out range, contribute as much as you’re eligible to deduct. If your income revokes your invitation to the deduction party completely, reevaluate your options.
Nondeductible IRA contributions can still be valuable: Money saved for retirement is money saved for retirement, and this money will still generate investment growth 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:
- 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. (Here’s more on Roth income limits.)
- Your employer retirement plan. You should max that out before making nondeductible IRA contributions.
If, after exhausting both of those options, you still want to consider nondeductible IRA contributions, consult an accountant before proceeding.
How to open a traditional IRA
Many financial services companies offer traditional IRAs, including online brokers, robo-advisors and banks.
When choosing a provider, look for low or no account fees; a large selection of low-cost, no-transaction-fee mutual funds and commission-free exchange-traded funds; and quality customer service. You can open the account online, so be ready with general information — Social Security number, birthday, contact information and employer details.
A traditional IRA isn’t an investment, but an investment account. Once you deposit money into your account, you’ll select from investments accessible through that provider, including stocks, bonds and mutual funds. After opening an account, it’s worth taking the time to learn how to invest in your IRA.
» See our recommendations: The best IRA providers