What is Traditional IRA & Contribution Limits

What is a Traditional IRA?

Traditional IRA: traditional individual retirement account is a tax-deferred retirement arrangement which lets individuals make investments by directing their pre-tax income.

  1. The IRA contribution limit has gone up from $5,500 in 2018 to $6,000 or $7,000 in 2021 if you are 50 years old or above. Even if you have an existing retirement plan at workplace such as the 401(k), you can still use the traditional individual retirement account to save for future.
  2. You can contribute to a traditional individual retirement account irrespective of whether you qualify for the tax deduction or not. Traditional individual retirement account contributions are debited in the year they are made in case you are eligible for the tax deduction.
  3. Investments are generally tax-deferred which imply that your gains will not be taxed until you withdraw them.
  4. Distributions made towards retirement are taxed under the ordinary income category.
  5. Early withdrawals are possible only if they meet specific conditions or else they may be taxed as income and penalty charge of 10% is applicable.
  6. Traditional IRA’s are particularly attractive due to their upfront tax deduction especially if you are looking to slash your tax bill in the present day. In addition, you stand a fair chance of reducing your overall tax burden if you choose a traditional IRA where you can expect your tax rate to go down after retirement.
  7. On the other hand, Roth IRA’s presents an alternative strategy: the tax benefit of a traditional IRA is reversed by these accounts. You contributions are tax-deduction free and your withdrawals also come out tax-free in retirement. Your investment earnings are tax-free as long as you abide by the Roth IRA rules.

How Do You Qualify For A Traditional Individual Retirement Account?

  1. A traditional individual retirement account can be opened by everyone and contributed to.
  2. Not all individuals are qualified to deduct their contributions to a traditional IRA.
  3. The IRS limits your opportunity to squeeze too much from the system which is why the amount of IRA contribution an individual can deduct is reduced if one of the spouses has a retirement plan at work.

Traditional IRA Income Limits For 2021:

Status of Filing Married spouses filing jointly and your work covers your retirement plan Married spouses filing jointly and one of the spouses is covered at work by a retirement plan Single or head of household and your work covers your retirement plan Married but filing separately and one of the spouses is covered at work by a retirement plan
Adjusted Gross Income for Full Deduction $105,000 or less $198,000 or less $66,000 or less Not available
Adjusted Gross Income for Partial Deduction More than $105,000 but less than $125,000 More than $198,000 but less than $208,000 More than $66,000 but less than $76,000 Less than $10,000
Adjusted Gross Income for No Deduction $125,000 or more $208,000 or more $76,000 or more $10,000 or more

 Benefits of Traditional IRA’s

  • A conventional IRA can be opened and contributed to without any income caps.
  • Irrespective of whether you can itemize deductions on your tax returns or not, you can still claim the deduction if you qualify for the tax deduction on contributions.
  • Tax-deferred growth in traditional individual retirement accounts means that all the gains you enjoy are tax-free in a standard brokerage account.
  • Eligible college expenses can be paid using the traditional IRA without having to pay an early distribution penalty even if you are paying taxes on the distribution.
  • Up to $10,000 can be used from a traditional IRA to contribute towards purchasing one’s first home; however, you will have to pay taxes on the distribution without any penalty.
  • After turning 70 and a half years old, an individual must start taking distributions which are called “required minimum distributions.” However, there are required minimum distributions in the case of Roth IRA’s. Additionally, you cannot make any more contributions to your account after reaching the age of seventy and a half.
  • The possibility to deduct IRA contributions may go down or get eliminated altogether in the case of higher incomes if you are covered at your workplace by a retirement plan.

Non-deductible Individual Retirement Account:

Technically speaking, there are no hard and fast rules when it comes to traditional IRA income limits for eligibility like in the case of the Roth IRA. However, if you are covered at work by a retirement plan and also earn a lot in order to contribute to a Roth IRA, then you earn too much to subtract your contributions towards a traditional IRA.

Therefore, you are left with the workplace plan which you should certainly take advantage of in any circumstance. You should make the most of it particularly if your employer provides matching amount and the non-deductible IRA.

The name says it all – a non-deductible IRA is a type of traditional IRA in which your contributions are not deducted. It may sound like just any other conventional taxable investment account superficially; however, it is not, for one major reason. Although there is no benefit on the tax end for contributing towards it, any earnings in your account in the form of investment returns will be tax-deferred till the time you take in distributions in retirement.

That is the point when you will pay taxes on gains on your investment similar to a standard traditional IRA.

Is it a Good Idea to Contribute if You Cannot Deduct?

Although you cannot deduct, it is still a valuable idea to indulge in IRA contributions. Your retirement fund should not just be languishing in your conventional bank accounts but more needs to be done since your investment earnings will still grow without taxes. There might be a challenging aspect to this since you will have to constantly keep a tab upon post-tax contributions by filing IRS Form 8606 every year so that you are not again when you withdraw your retirement distributions.

Your Retirement Plan That is Employer-Sponsored:

You should take as much advantage of it as possible before going ahead with the non-deductible IRA contributions. In fact, doing so will qualify you for an IRA deduction since your taxable income for the year is reduced because of your contributions to the workplace plan.

Opening a Traditional IRA Account (Traditional Individual Retirement Account) – where can you do so?

Traditional IRA Account: Traditional individual retirement accounts are offered by many financial services such as online brokers and robo-advisors. An online broker is a good option for your account if you want to choose your own investments for your individual retirement account. You have the option of selecting from investments accessible through a particular provider in the case of a broker. This includes mutual funds, stocks and bonds. The bottom line to remember is that a traditional IRA is not an investment in itself but an account that stores or holds your investments.

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