Table of Contents
- Traditional IRA – One of Many Retirement Account Options
- What is a Traditional IRA?
- How Does the Traditional IRA Work?
- 2022 Traditional IRA Contribution Limits
- What Are the 2022 Income (Phase-Out) Limits for Traditional IRA Contributions?
- What Do You Do If Your Income Exceeds the Phase-Out Range?
- What Are the Benefits of a Traditional IRA?
- Rollover IRA vs. a Traditional IRA
- Is a Traditional IRA a Good Investment?
The traditional IRA is one of the most effective ways to invest for retirement. It offers investors tax benefits and the ability to grow your investment over time without the drag of taxes slowing it down. It’s also easy to make traditional IRA withdrawals during retirement.
They are not a one-size-fits-all retirement account, however. Traditional IRA withdrawals are taxed at the time they are made (and there may be penalties if withdrawals are made prior to age 59½). And there are also income limits to the tax deductions.
Let’s take a deep dive into the traditional IRA and examine what it is, who is eligible and more.
Traditional IRA – One of Many Retirement Account Options
There are dozens of ways you can invest your money, but that doesn’t mean it has to be confusing. Each investment opportunity has unique benefits, and the first step is to define your investment goals.
When looking at retirement investing, it’s best to focus on those types of investments that offer tax benefits. These usually fall into two main categories:
- Employer-sponsored retirement plans, such as a 401(k) or the Thrift Savings Plan
- Individual plans, such as an IRA
For many investors, an individual retirement arrangement (IRA) is the ideal way to save toward retirement and earn the most from their investments. An IRA can be used alone or in conjunction with other retirement accounts. Within the world of IRAs, there are several options from which to choose, including the Roth IRA and several IRAs designed for self-employed individuals and those working for small companies. Here we look specifically at the traditional IRA and who benefits most from this type of retirement account.
What is a Traditional IRA?
A traditional IRA is a savings plan that allows contributors to use pre-tax dollars to invest in stocks, bonds, CDs, mutual funds and other investment vehicles.
The traditional IRA is a popular savings tool for individuals who may not have access to employer-sponsored retirement plans or for those who want to have an additional retirement account that offers tax-deferred growth on investments.
How Does the Traditional IRA Work?
To open a traditional IRA, you must be under the age of 70½ and make contributions from taxable compensation.
You can open a traditional IRA in a number of places, such as at your local bank, a brokerage company or a mutual fund company.
Note: the HEROES Act allows deployed military members to contribute to an IRA with tax-free combat pay.
2022 Traditional IRA Contribution Limits
The maximum contribution limits allowed per year cannot exceed $6,000 unless you are 50 years of age or older, in which case you can contribute an additional $1,000 in catch-up contributions.
Traditional IRAs share the same contribution limit as the Roth IRA. You can contribute $6,000 ($7,000 with catch-up contributions) between both accounts. This means you can contribute the full amount to a traditional IRA or a Roth IRA, or you could contribute $3,000 to each account or any combination that does not exceed the total annual contribution limit.
What Are the 2022 Income (Phase-Out) Limits for Traditional IRA Contributions?
Owners of a traditional IRA may deduct contributions when filing their income taxes, as long as they fall within income thresholds set forth by the IRS. This lowers your taxable income in the current year, which is a nice benefit.
If your modified adjusted gross income (MAGI) exceeds the amount allowable by the IRS, contributions may qualify for a partial deduction. If your income exceeds the allowable MAGI, you will be ineligible to contribute to a deductible traditional IRA (more on this in a moment).
These income limits are commonly referred to as the phase-out range, and for 2022, the following limits are in place:
- $68,000 – $78,000 for those filing single or head of household
- $109,000 – $129,000 for married couples filing jointly
If you earn income below the lower limit, can deduct the full amount of your IRA contributions from your taxes. If your income falls within the above ranges, you can deduct a partial amount of your contributions. If your income exceeds these limits, you can not deduct any of your IRA contributions.
The following table shows the full traditional IRA tax deduction phase-out income ranges.
| Filing Status | Modified AGI | Deduction |
|---|---|---|
| Single or head of household | $68,000 or less | Full deduction up to the amount of your contribution limit |
| More than $68,000 but less than $78,000 | Partial deduction | |
| $78,000 or more | No deduction. | |
| Married filing jointly or qualifying widow(er) | $109,000 or less | Full deduction up to the amount of your contribution limit |
| More than $109,000 but less than $129,000 | Partial deduction | |
| $129,000 or more | No deduction | |
| Married filing separately | Less than $10,000 | Partial deduction |
| $10,000 or more | No deduction | |
| If you file separately and did not live with your spouse at any time during the year, your IRA deduction is determined under the "Single" filing status. | ||
What Do You Do If Your Income Exceeds the Phase-Out Range?
ou can still contribute to a traditional IRA if your income exceeds the limits for tax deductible contributions. However, you would need to contribute to a non-deductible IRA. Another option would be to contribute to a Roth IRA, which has different rules.
Roth IRAs are different in that the contributions are made with money that has already been taxed. The money then grows in your Roth IRA account and is not taxed at withdrawal, provided you meet the withdrawal requirements (there is a five-year rule and a 59½ minimum age requirement).
Roth IRAs also have income limits, which need to be considered before deciding to contribute to a Roth instead of a traditional IRA.
If you exceed both the deductible traditional IRA and the Roth IRA income limits, then consider contributing to a non-deductible traditional IRA. This still allows you to contribute to an IRA, even though you don’t get the tax deduction when you file your return.
There are some advanced tactics you can do with these contributions, however, such as converting them to a Roth IRA at a later date. I recommend reading up on this, as it is a more advanced topic and may cause a taxable event. You can consult with a tax professional or a fee-only financial planner for more information.
There are pros and cons to both traditional and Roth IRAs. I recommend comparing them to determine which is better for your situation.
What Are the Benefits of a Traditional IRA?
When contributions qualify as a tax deduction, owners of a traditional IRA can benefit by lowering their taxable income when they file their federal tax return. This allows for tax-deferred growth on contributions and earnings throughout the lifetime of the IRA.
It is important to note that distributions from a traditional IRA are subject to taxation at the time of distribution (when you make withdrawals from your investments).
If distributions are made from a traditional IRA before the account owner is 59½ years of age, they will be subject to a 10% early withdrawal penalty as well. Contributions to a traditional IRA must cease when the account owner reaches age 72, at which time required minimum distributions (RMDs) must begin. Failure to take the required mandatory distributions will result in a 50% penalty of the required withdrawal amount from the IRS.
Rollover IRA vs. a Traditional IRA
If you have a 401(k), 403(b), or a previous employer-sponsored retirement account, you can roll those funds into an IRA. This may be helpful if you are between jobs or you want to consolidate multiple retirement accounts into one place.
Like a traditional IRA, a rollover IRA lets you preserve the tax-deferred status of your retirement assets, and you don’t pay early withdrawal penalties or taxes when you make the transfer.
Instead, you’ll pay taxes on it when you withdraw the funds, according to whichever income tax bracket you fall under in retirement.
Annual contribution limits do not apply to the rolled-over amount, but any contributions you make outside of the rollover are subject to the $6,000 contribution limit. If you’re over 50 years old, you can contribute an extra $1,000 catch-up contribution.
If you don’t make any additional contributions, you can reverse the rollover and put your funds in a future employer’s retirement plan later.
Depending on your investment goals and risk tolerance, you can roll your old account into several possible IRA options, including stocks, bonds and mutual funds..
But, be aware there may be tax implications if you roll company stock into an IRA.
Per current IRS regulations, your former employer may complete your request through a direct or indirect rollover of your retirement account funds.
With a direct rollover, your plan administrator delivers your distribution to the IRA provider. You don’t take possession of your funds, so you don’t have to pay taxes on them.
Some employers may complete the process with an indirect rollover. In this case, you would receive some or all the funds from your retirement account to place into another eligible plan within 60 days.
Your employer may withhold 20% of the funds for federal income tax, but you can recover this deduction in the form of a tax credit when you file your tax return and deposit it into the rollover IRA later.
Is a Traditional IRA a Good Investment?
The traditional IRA can be a great investment vehicle for individuals who understand the rules and fall within income-eligibility requirements. For many, the immediate tax benefits associated with the traditional IRA make this type of account attractive.
If you anticipate being in a lower tax bracket at the time of distribution, the traditional IRA may be the right account for you. As with any other investment strategy, it is important to understand the benefits as well as drawbacks to make the best decision regarding your retirement savings.
For more information about IRAs, see:
IRS Publication 590, Individual Retirement Arrangements (IRAs).
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