Text size: aA aA aA
Generally, investors have two options for their individual retirement accounts (IRAs). The first option is a traditional IRA, and the second option is a Roth IRA (named for the account's congressional sponsor), which features — among other benefits — the ability to receive federally tax-free earnings under certain circ*mstances. In this article, we'll discuss the features of the traditional IRA. You may want to review material outlining the Roth IRA — or talk to a financial professional — before you make a decision as to which IRA may be suitable for you.
What is a traditional IRA?
A traditional IRA allows any investment earnings to grow tax deferred until withdrawn, typically at retirement. Generally, if you have earned income, you can establish as many IRAs as you want. You may also have an IRA even if you participate in a qualified pension, profit sharing, or other retirement plan. Your entire contribution may not be deductible on your federal income tax return, depending on your income and whether you (or your spouse) participate in an employer-sponsored retirement plan.
Traditional IRAs offer two distinct potential advantages in terms of taxes: potential deductibility of contributions and tax deferral on any investment earnings.
Rules on contribution limits
In 2023, the maximum annual contribution an individual can make to all of his or her IRAs is $6,500 (in general, married couples filing jointly can contribute a total of $13,000, even if only one spouse has income). Thereafter, the contribution limit will be adjusted for inflation. Individuals aged 50 and older are able to take advantage of "catch-up" contributions to IRAs. The allowable catch-up contribution is $1,000 per year. Starting in 2024, this catch up limit will be indexed for inflation. Maximum contributions may not exceed earned income.
In addition, you can open an IRA or make contributions to an existing IRA as late as the deadline for filing a federal income tax return for that year (without extensions). That means you would generally have until April 15, 2024 to make your 2023 IRA contributions.
Tax treatment of IRAs
Contributions to a traditional IRA may or may not be deductible from your earned income in a given tax year depending on your situation. Income limits apply if either you or your spouse participates in an employer-sponsored retirement savings plan. Deductibility is phased out over certain ranges of income as follows:
| Single Filers | Joint Filers | |
|---|---|---|
| Those covered by an employer-sponsored retirement plan | $73k - $83k | $116k - $136k |
| Those not covered by an employer-sponsored retirement plan, but filing a joint return with a spouse who is covered | N/A | $218k - $228k |
| * Based on modified adjusted gross income (MAGI). | ||
If you are married, but you and your spouse file separate income tax returns, you may take a partial deduction for contributions to a traditional IRA if your MAGI is less than $10,000. If your MAGI is $10,000 or more, no deduction is available.
Potential tax-deferred compounding
The ability to make tax-deductible contributions to a traditional IRA can help your current tax situation. But you may want to invest in an IRA whether or not your contributions are deductible. Why? A significant advantage of investing in an IRA is potential tax-deferred compounding of any investment earnings over the long term.
For example, if you contribute $100 every month for 30 years to a tax-deferred IRA, you could potentially have a balance of $100,452, assuming a 6% average annual rate of return. If you made non-deductible contributions, the $36,000 non-deductible contributions would be tax-free and only the earnings ($64,452) would be subject to income tax at the time of distribution.Footnote1
Change jobs but keep your retirement moneyFootnote2
IRAs can also come in handy if you participate in an employer-sponsored retirement plan such as a 401(k) plan and leave that job. You can typically take a distribution from the 401(k) plan on termination of employment, and roll over your 401(k) money directly into an IRA or your new employer's plan, if offered, and avoid owing current income tax on the distribution. You have choices about what to do with your employer-sponsored retirement plan accounts. Depending on your financial circ*mstances, needs and goals, you may choose to roll over to an IRA or convert to a Roth IRA, roll over an employer-sponsored plan from your old job to your new employer, take a distribution, or leave the account where it is. Each choice may offer different investment options and services, fees and expenses, withdrawal options, required minimum distributions, tax treatment (particularly with reference to employer stock), and different types of protection from creditors and legal judgments. These are complex choices and should be considered with care. For more information visit our rollover page or call Merrill at 888.637.3343. Starting after December 31, 2023, if you terminate employment and your 401(k) account balance is less than $7,000, your employer may automatically distribute your account balance to a default IRA.
If your 401(k) distribution is rolled into a default IRA upon your termination of employment, the amount rolled into the default IRA may be automatically transferred to your new employer's retirement plan. You may contact your employer for more details.
You could also choose to receive part or all of your money as a cash distribution. But any amounts withdrawn will be subject to taxes and may also be subject to a 10% early withdrawal additional federal income tax if you are under age 59½, unless an exception applies.
Withdrawing from your IRA
Generally, any distribution you receive from an IRA before you attain age 59½ is subject to a 10% early withdrawal tax required under the Internal Revenue Code in addition to federal and state income tax. Beginning at age 59½, you can withdraw money (of which any deductible contributions and investment earnings are taxable at your then-current income tax rate) from your IRA as desired without the 10% additional tax, whether or not you are still employed.
But, as with any rule, there are exceptions. Distributions before age 59½ are not subject to the additional tax under certain circ*mstances, some examples are when:
- You become permanently disabled;
- You die before age 59½ and distributions are made to your beneficiary or estate after your death;
- You make withdrawals to pay deductible medical expenses;
- You make withdrawals for a qualified first-time home purchase (lifetime limit of $10,000);
- You make withdrawals to pay qualified higher education expenses for yourself, a spouse, children, or grandchildren.
By April 1 following the year in which you reach age 73, you must begin withdrawals from your IRA (this age will increase to 75 in 2033). An advantage of taking only the required minimum distribution amount is that the balance may continue to compound tax-deferred. However, if your distributions in any year after you reach age 73 are less than the required minimum; you may be subject to an additional tax of up to 25% of the amount that should have been withdrawn but was not. If you take the correct distribution in the two-year period following the year when you should have begun taking distributions, the additional tax may be further reduced to 10%.
Consult your Financial Professional
An IRA can become an important part of your personal retirement savings program, providing a foundation for your financial security. That's why it is so important to start planning today. Consult with your financial professional to help you determine how an IRA could help make your financial future more secure. Your financial professional can also work with you and your legal and/or tax advisors before you make any financial decisions.
Footnote1 This is a hypothetical example used for illustrative purposes only. It is not representative of any particular investment vehicle. It assumes a monthly contribution of $100 and a 6% average annual total return compounded monthly. Your investment results will be different. Tax-deferred amounts accumulated in a traditional IRA are taxable on withdrawal.
Footnote
You have choices about what to do with your employer-sponsored retirement plan accounts. Depending on your financial circ*mstances, needs and goals, you may choose to roll over to an IRA or convert to a Roth IRA, roll over an employer-sponsored plan from your old job to your new employer, take a distribution, or leave the account where it is. Each choice may offer different investment options and services, fees and expenses, withdrawal options, required minimum distributions, tax treatment (particularly with reference to employer stock), and different types of protection from creditors and legal judgments. These are complex choices and should be considered with care. For more information visit our rollover page or call Merrill at 888.637.3343.
© SS&C. Reproduction in whole or in part prohibited, except by permission. All rights reserved. Not responsible for any errors or omissions.
The material was authored by a third party, DST Retirement Solutions, LLC, an SS&C company ("SS&C"), not affiliated with Merrill or any of its affiliates and is for information and educational purposes only. The opinions and views expressed do not necessarily reflect the opinions and views of Merrill or any of its affiliates. Any assumptions, opinions and estimates are as of the date of this material and are subject to change without notice. Past performance does not guarantee future results. The information contained in this material does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation, offer or solicitation for the purchase or sale of any security, financial instrument, or strategy. Before acting on any recommendation in this material, you should consider whether it is in your best interest based on your particular circ*mstances and, if necessary, seek professional advice.
Because of the possibility of human or mechanical error by SS&C or its sources, neither SS&C nor its sources guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall SS&C be liable for any indirect, special or consequential damages in connection with subscriber's or others' use of the content.
Merrill, its affiliates, and financial advisors do not provide legal, tax, or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.
MAP5459813-03312024
As an expert in financial planning and retirement accounts, it's evident that the article provides comprehensive information on traditional Individual Retirement Accounts (IRAs). The article covers various aspects of traditional IRAs, from their basic features to contribution limits, tax treatment, potential advantages, and considerations for withdrawal. Here's a breakdown of the key concepts covered in the article:
1. Traditional IRA Overview:
- A traditional IRA allows tax-deferred growth of investment earnings until withdrawal, typically during retirement.
- Individuals with earned income can establish multiple IRAs, even if they participate in other retirement plans.
- Deductibility of contributions and tax deferral on investment earnings are two potential tax advantages.
2. Contribution Limits:
- In 2023, the maximum annual contribution to all IRAs for an individual is $6,500, with married couples filing jointly having a total limit of $13,000.
- "Catch-up" contributions of $1,000 per year are allowed for individuals aged 50 and older.
- Contribution limits may be adjusted for inflation in subsequent years.
3. Tax Treatment:
- Deductibility of traditional IRA contributions depends on factors such as income, participation in employer-sponsored plans, and filing status.
- Deductibility is phased out over specific income ranges.
- Spouses filing separately may qualify for a partial deduction if their modified adjusted gross income (MAGI) is below $10,000.
4. Tax-Deferred Compounding:
- Making tax-deductible contributions can enhance current tax situations.
- The article emphasizes the potential advantage of tax-deferred compounding for long-term investment growth.
5. Changing Jobs and IRA Rollovers:
- Traditional IRAs can be useful when transitioning from an employer-sponsored retirement plan (e.g., 401(k)) to a new job.
- Options include rolling over the 401(k) balance to an IRA or a new employer's plan.
6. Withdrawal Rules:
- Distributions before age 59½ are generally subject to a 10% early withdrawal tax, in addition to federal and state income tax.
- Exceptions to the early withdrawal tax include disability, death, medical expenses, first-time home purchase, and education expenses.
7. Required Minimum Distributions (RMDs):
- By April 1 following the year in which an individual reaches age 73 (increasing to 75 in 2033), RMDs must begin.
- Taking only the required minimum distribution allows the remaining balance to continue compounding tax-deferred.
8. Consulting a Financial Professional:
- The article advises consulting a financial professional for personalized guidance on IRA decisions.
- It emphasizes the importance of considering various factors, including investment options, fees, and tax implications.
9. Footnotes and Legal Disclaimer:
- The article includes hypothetical examples (e.g., tax-deferred compounding) for illustrative purposes.
- There are footnotes and legal disclaimers cautioning readers about the complexity of IRA decisions and advising consultation with financial professionals.
In conclusion, this article serves as a comprehensive guide to traditional IRAs, providing valuable insights for individuals considering retirement planning and investment decisions.
