Of the various types of Individual Retirement Accounts (IRAs), Roth IRAs and traditional IRAs are the most common. In the June 2017 blog, we provided a basic overview of Roth IRAs. In this month’s blog, we will provide a basic overview of traditional IRAs.

Traditional IRA:

  • Age restrictions: There are age restrictions in which an individual can contribute to a traditional IRA until age 70 ½.
  • Income implications: An individual must have taxable compensation or be self-employed to start and fund a traditional IRA.
  • Contribution limits: For 2017, the contribution limit is $5,500 for individuals under 50 years of age. If you are 50 or older, you can make an additional “catch-up” contribution of $1,000, for a total contribution of $6,500.
  • Tax deductibility: Some or all of an individual’s annual contribution may be tax deductible. Deductibility depends on your modified adjusted gross income and whether an individual (and his/her spouse, if applicable) is covered by a retirement plan at work.
  • Taxes on withdrawals: When you make a withdrawal from a traditional IRA of earnings or contributions that were deducted on a tax return, withdrawals will be taxed as ordinary income. If you made any non-deductible contributions to your traditional IRA, that portion will not be taxable upon withdrawal, but the earnings on it will be.
  • Early distributions: There is a 10% penalty for withdrawing contributions and earnings before 59 ½ years of age. There are certain exemptions from the penalty, but not the tax, for instances such as a qualified first-time home purchase, college expenses, and unreimbursed medical expenses.
  • Required Minimum Distributions (RMDs): Traditional IRAs do require minimum distributions. The first RMD is required by April 1 of the year following the year you reach 70 ½ years of age. Subsequent RMDs must be made annually by December 31st.
  • Traditional IRA conversion to Roth IRA: A taxpayer can convert a traditional IRA to a Roth IRA. Generally, any untaxed amounts converted will be included in taxable income in the year of the conversion, but the 10% penalty does not apply. This may be beneficial if the taxpayer is currently in a low tax bracket and expects to be in a high tax bracket during retirement when the IRA money will be withdrawn.

As with any financial decision you make, it is advised that you review all of your retirement planning options with your financial and tax advisor before making contributions to or withdrawals from your retirement assets.