For many people, a traditional IRA can be an effective way to invest more money toward retirement while lowering their tax bill. However, this type of retirement account does come with limitations, including how much you’re allowed to contribute each year and when you can take withdrawals.
How does a traditional IRA work?
A traditional individual retirement account, or IRA, lets you contribute money towards retirement with pre-tax income. That means you don’t have to pay taxes on eligible contributions in the year you make them. So if you contribute, say, $1000 in 2021, you can reduce your taxable income by that same amount when you file your federal tax returns for that year. Experts consider this one of the primary traditional IRA benefits. Additionally, your invested funds aren’t subject to taxes until you take distributions from your account.
A traditional IRA is a type of account that you can open through a brokerage firm or robo-advisor. You may choose your own investment strategy based on your risk tolerance and timeline for retirement.
Traditional IRA withdrawals
Since this type of account is designed to help you prepare for retirement, you must wait until you turn 59 ½ before you can begin taking distributions from your traditional IRA. If you withdraw funds before that age, you’ll have to pay a 10% penalty in addition to state and federal income taxes.
There are some exceptions if you use the early withdrawn funds for certain purposes, such as:
- Buying or building a first home (lifetime limit of $10,000)
- Expenses related to giving birth or adopting a child (limit of $5,000)
- Paying for higher education expenses, if you qualify
- Paying for medical expenses not covered by insurance, if those expenses amount to more than 7.5% of your income
- You become disabled
- The IRS levies funds to repay tax debt
Traditional IRAs also come with required minimum distributions (RMD). Once you reach age 72, you are required to withdraw funds each year (and consequently, pay taxes on them). You may withdraw more than the RMD.
Who can open a Traditional IRA? Traditional IRA income limits
Unlike a Roth IRA, there are no income limits for contributing to a traditional IRA. However, the size of your eligible income tax deduction may be impacted if you’re also covered by an employer-sponsored retirement plan.
The 2021 phase-out ranges are as follows for anyone with access to a workplace 401k plan:
- Single taxpayers: $66,000 to $76,000
- Married filing jointly: $105,000 to $125,000
- Not covered by workplace plan, but married to someone who is: $198,000 to $208,000
Maximum traditional IRA contribution limits
The IRS announces new maximum contribution limits each year for traditional IRAs. Individuals who are 50 years or older may contribute more as a catch-up contribution, since they’re closer to retirement age.
Here are the 2021 traditional IRA contribution limits:
- $6,000 (through 49 years old)
- $7,000 (50 years or older)
You may still contribute more money to your IRA than those limits, but you won’t receive any tax benefits.
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