Do you want to open a retirement account but are not sure if a traditional IRA is the best choice for you? A traditional IRA is right for you if you don’t have an employer retirement plan such as a pre-tax 401(k) or if you want to increase your before-tax contributions toward retirement. One of the biggest benefits of a traditional IRA is that your contributions might be tax deductible which lowers your tax liability. Additionally, you grow the account on a tax-deferred basis and pay applicable tax during retirement.
You can open a traditional IRA from a local bank, credit union, brokerage company, or other financial institution that offers retirement saving services. If you are not sure whether a traditional IRA is right for you, this article will walk you through the benefits of a traditional IRA to help you make the right decision.
Without further ado, here are traditional IRA benefits you should know.
What is a traditional IRA?
The traditional IRA is one of the most useful individual retirement accounts(IRAs) you can open to supplement your 401(k) plan. A traditional IRA allows you to grow your account on a tax-deferred basis and pay applicable taxes during retirement. Contributions to traditional IRAs may be deductible depending on your income, filing status, and other benefits you have from your employer.
There are a lot of benefits of a traditional IRA which include a wide variety of investment options, fewer fees, and tax benefits. The downside of the plan is that your contributions might not be tax deductible and the traditional IRA limits are lower than 401(k) plans. Additionally, you might pay tax during retirement and the account comes with required minimum distributions(RMDs).
To help you make the right retirement saving decision, here are the benefits of a traditional IRA you should know.
More details: What is a Traditional IRA and how does it work?
What are the benefits of a traditional IRA?
The traditional IRA can help you maximize your retirement savings and give you tax benefits at the same time. The account can supplement the benefits you get from your work and provide you with investment flexibility.
The following are benefits of IRA you need to know before you open the account.
1. Tax-deferred growth
When it comes to retirement plans, tax benefits become the biggest factor. By delaying taxes or paying no taxes, your account grows much faster than other investment accounts you can choose such as a brokerage account or a savings account.
One of the benefits of a traditional IRA is that your account will grow on a tax-deferred basis. This means you won’t be required to pay taxes on your account’s earnings until you are taking withdrawals or when you have reached 73 when RMDs kick in. By keeping money in the account for many years without paying taxes, the account grows much faster due to compound interest which is one of the best strategies to build wealth.
Keep in mind that some of the contributions to your IRA may not be deductible. The deductible amount will all depend on other plans you have from work, filing status, and your income level.
The IRS requires that you take required minimum distributions(RMDs) from your traditional IRA account when you turn 73. Failure to take RMDs may result in a 50% tax penalty on the amount you did not distribute on time.
2. Traditional IRA comes with a wide range of investments
Unlike 401(k) plans where you are limited to investment options that come with the plan; the traditional IRA comes with a wider range of investment options. You are not limited to a handful of index funds, mutual funds, or ETFs pre-selected for you.
With a traditional IRA, you can invest in individual securities such as bonds, individual stocks, ETFs, REITs, etc. Additionally, you will have options for annuities, mutual funds, and index funds. These investments make the traditional IRA a perfect choice for retirement savings.
3. It is easy to set up and manage a traditional IRA
It is very easy to open a traditional IRA. You can open an IRA from your bank, brokerage company, or investment company that offers retirement services.
Most companies have an online application that takes 15 to 30 minutes. If you don’t like the online application, you can call the company and speak with a representative to set up an account on the phone. In case you prefer an in-person service, you can stop by your local bank or credit union to open an account in person.
4. Your contributions may reduce your taxable income
Another benefit of a traditional IRA is that qualified contributions to the account may be tax deductible. Your eligibility for tax deduction will depend on your income limits, filing status, and other benefits such as a 401(k) plan from work.
Traditional deduction eligibility when you have other retirement benefits from work
The IRS has income phase-out ranges that determine your eligibility for a deduction on traditional IRA contributions. These phase-out ranges are based on your income, filing status, and other benefits you have from work such as a pre-tax 401(k) plan.
Here are the traditional IRA phase-out ranges for 2024. If you are not covered by a workplace, phase-out ranges will not apply.
If you are single or head of household and your modified AGI is at most $77,000, you will have a full deduction on your traditional IRA contribution. On the other hand, if your income is over $77,000 but lower than $87,000, you will get a partial deduction on your traditional IRA contributions. You will not qualify for a tax deduction if your income is higher than $88,000.
If you are married and filing jointly and your modified AGI is equal to or less than $123,000, you will have a full tax deduction on your traditional IRA. However, if your modified AGI is higher than $123,000 but less than $143,000, you will have a partial tax deduction on your contributions. When your modified AGI is higher than $143,000 you will not be eligible for deduction.
If you are married but filing separately and your modified AGI is lower than $10,000, you will qualify for a partial deduction. You will not be eligible for deductions if your income is equal to or higher than $10,000 under the same filing status.
Difference between a traditional IRA and a Roth IRA?
Both Roth IRA and traditional IRA are opened by individuals themselves from a bank, brokerage firm, or other investment companies. These two accounts come with tax benefits and contribution limits are the same for 2024. For 2024, the contribution limits to both IRAs are $7,000 or $8,000 if you are 50 or older.
The main difference between a traditional IRA and a Roth IRA is how your tax benefits are realized.
For the traditional IRA, contributions to the account can be tax-deductible and the account is grown on a tax-deferred and tax is due when you are taking distributions. Additionally, the traditional IRA requires RMDs when you turn 73. Failure to take RMDs may result in a 50% tax penalty on the amount not distributed on time.
On the contrary, the contributions to a Roth IRA are after-tax money. That means the account does not give you upfront tax benefits. Instead, you will grow the account on a tax-free basis and pay no income tax on qualified withdrawals. Also, the Roth IRA does not require RMDs as long as the account belongs to the original owner.
More retirement tips
Pros and cons of Roth IRA: Is Roth IRA right for you?
Roth 401(k) vs. Roth IRA: What is the difference?
