A traditional IRA is an account that allows you to save for your retirement. It is in addition to the employer-sponsored retirement account and is an account you hold individually. A contribution to the IRA is made on a pre-tax basis which means the amount invested into the account is deductible from the taxable income. It will result in a low taxable income and subsequently less income tax for the year.
Besides this valuable tax deduction benefit, the amount invested in the account grows tax-deferred. This means that any capital gain or interest from this investment is not taxed and the same is deferred until you withdraw money from the account during retirement.
The withdrawal amount will be taxed at the income tax rate prevalent at the time of withdrawal. Hence, if you are fortunate to have a lower tax bracket at the time of retirement, you will owe less amount in taxes on your withdrawals than you would if you paid the tax now.
How does traditional IRA work?
All individuals are eligible to open a traditional IRA and the contribution into the account should be made by the tax filing deadline, which is April 15. An account can be opened through a mutual fund company, brokerage or even a bank. This amount will be invested into mutual funds, stocks, bonds, and other investments. You can also choose a fund that has a mix of stocks and bonds. The fund should align with your long-term goals.
A lot of institutions offer a specific-date retirement fund and they are slightly more aggressive and give you higher returns. As you get closer to retirement, the balance of investments held in your account will become more conservative. It is best to move from aggressive investment strategy to conservaitve strategy as you approach retirement.
It is up to you to decide when to contribute to the IRA. You can do it occasionally or set up regular contributions every month. This amount can be claimed as a deduction at the time of filing the taxes.
Benefits of Traditional IRA
There are several benefits of IRA that you need to be aware of. Let us discuss them in detail.
The amount you contribute during the year will be fully tax deductible as long as the employer does not give you a qualified retirement plan. Individuals who are covered under the employer’s plan may be eligible to receive a tax deduction but it will depend on the filing status and the income threshold.
Individual fillers that also have a retirement plan from the company and earn $56,000 or less will be eligible for a full deduction. Married fillers who have the company’s plan and earn $89,000 or less are also eligible for a full deduction.
Low tax liability
A huge advantage of traditional IRA is that the contributions can grow tax deferred and you can make withdrawals at the later years. It will automatically bring down the tax liability. Since your income is often lower in the years of retirement, the amount withdrawn will be subject to low taxes.
No restriction with regard to income limits
All individuals are eligible to enroll in the traditional IRA. There is no income limit to participate.
It is possible to pass assets to the beneficiaries after the death.
All contributions will be protected from the creditors.
Several retirement accounts
You can set up a traditional IRA with another retirement plan. The contribution might not be fully tax deductible if you have adequate qualified retirement plan.
In traditional IRA, you can enjoy tax free growth of the assets. There will be no taxes applicable on the capital gain or dividends until distribution.
Why is the traditional IRA better than Roth IRA?
A lot of individuals are confused between the traditional IRA and Roth IRA. A traditional IRA has a huge advantage over Roth. The tax advantage which makes the contributions tax deductible benefits individuals to a significant extent. The same is not applicable to Roth. It is a post-tax retirement savings account and the withdrawals will not be taxed but the contribution will remain taxable.
A traditional IRA is the best way to start saving for retirement. It is recommended to carefully choose the fund for investment keeping your long-term goals in mind.