A traditional individual retirement account (IRA) can help you save for retirement with pretax dollars while allowing for tax-deferred growth.
A traditional individual retirement account (IRA) is a tax-advantaged account designed specifically for retirement savings. Unlike Roth IRAs, which you fund with after-tax dollars in exchange for tax-free income in retirement, a traditional IRA offers the potential to save on taxes upfront when you contribute and defer taxes until you take distributions from the account.
Once you open and fund a traditional IRA, you can invest your assets in a variety of investments, including:
These choices give you the opportunity to diversify your savings with an appropriate mix to help meet your retirement objectives.
Traditional IRAs can help you save on taxes while saving toward your retirement goals.
Anyone can contribute to traditional IRA if you have taxable compensation. However, your ability to deduct your traditional IRA contributions from your income taxes depends on how much you earn and whether you or your spouse is an active participant in an employer-sponsored retirement plan, such as a 401(k).
You can contribute up to 100% of your taxable compensation or the annual contribution limit, whichever is lower. Contribution limits are set every year by the IRS and are tied to cost-of-living adjustments. Keep in mind your total contribution can be no more than the annual limit for all your traditional and Roth IRAs combined.
IRA contributions must be made in cash and can be made at any time during the year up to the tax-filing deadline, not including extensions (generally April 15).
In addition to funding your own IRA, you can also fund an IRA on behalf of your spouse. If your spouse has no taxable compensation, you may be able to contribute up to the maximum IRS annual contribution limit for that account, too, as long as you file a joint tax return.
Eligible taxpayers can also receive the Saver’s Credit for their traditional IRA contributions in addition to the tax deduction. The Saver’s Credit is a nonrefundable tax credit of up to $1,000 for single filers ($2,000 for joint filers) that can help lower your tax bill.
Distributions of any pretax (deductible) contributions and earnings are taxed as ordinary income. However, distributions before age 59½ may be subject to a 10% early withdrawal penalty, in addition to regular income taxes, unless you qualify for a penalty exception.
Distributions of after-tax contributions (non-deductible) aren’t subject to taxes or penalties, since you’ve already paid taxes on those dollars. However, if you have pretax and after-tax assets in your traditional IRA(s), your distribution will include a mix of pretax and after-tax dollars based on the percentage each represents for your total IRA account value. This is known as the pro rata rule.
To determine the percentage of your distribution that’s made up of pretax dollars (and subject to taxes), the IRS looks at all your traditional IRAs (including SEP and SIMPLE IRAs), not just the IRA you took the distribution from.
What’s the difference between a traditional IRA and a Roth IRA?One of the main differences is the way contributions and withdrawals are taxed. Traditional IRA contributions are generally made with pre-tax dollars, any earnings growth is tax deferred and future withdrawals are taxed like income. Roth IRA contributions are made with after-tax dollars and future, qualified withdrawals are tax free.
Another difference is required withdrawals. If you have a traditional IRA, the IRS requires you to withdraw a minimum amount each year when you reach 73, known as a required minimum distribution (RMD). A Roth IRA has no RMDs.
What’s the difference between a 401(k) and a traditional IRA?A 401(k) plan through your employer is designed to allow you to contribute a percentage of your salary for retirement savings. Employer plans may offer a traditional 401(k) and a Roth 401(k) for employees. Like an IRA, a traditional 401(k) is funded with pre-tax dollars and distributions are taxed as ordinary income, while a Roth 401(k) is funded with after-tax dollars with the potential for tax free withdrawals in the future.
With a 401(k), your employer makes several decisions on your behalf — where your account is held, when you’re eligible to contribute, what investment options and services are available to you and when you can take distributions from your account, to name a few. 401(k) plans are generally less expensive than an IRA and can offer certain benefits that are unavailable to IRAs, such as employer matches, the ability to borrow against your assets, the ability to take penalty-free withdrawals beginning at age 55 if you meet certain criteria and the ability to delay RMDs while still working.
A traditional IRA is an individual account you contribute to and manage. It offers you more control and choice over where and how your contributions are invested as well as when you can access your funds. These accounts are not tied to your employer and are transferable between institutions at any time.
If you want to maximize your retirement savings, you can contribute up to annual limits for your 401(k) and a traditional IRA as long you meet the eligibility requirements.
Can I roll over my employer retirement plan to a traditional IRA?You generally must meet two criteria to be able to roll over your employer retirement plan to an IRA:
Additionally, Roth 401(k) assets may only be rolled over to a Roth IRA. Pre-tax 401(k) assets can be rolled over to a traditional or a Roth IRA. But, if you roll over pre-tax 401(k) assets to a Roth IRA, it’s considered a Roth conversion, and the amount that's rolled over will be taxed.
It’s also important to know that there are differences between employer plans and IRAs. Make sure you understand your options before rolling over. A financial advisor can help you determine whether rolling over makes sense for you.
Can I move my IRA to another provider?Yes, you can transfer your IRA to another provider at any time without tax consequences or tax reporting, as long as the assets move directly from your current IRA provider to your new IRA provider.
To move an existing IRA to Edward Jones, contact a financial advisor to help you determine the method best suited to your needs.
If you’re considering opening a traditional IRA, talk to us. Our financial advisors will work with you to determine what's important to you now and in the future. Together we’ll review your retirement options and design a personalized retirement strategy based on your investment goals. Contact us for a no-obligation consultation today.
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