Feb 10th, 2008
Working Backwards: What’s a Traditional IRA?
An Individual Retirement Account, also known as an IRA, is a term referring to what is now one of several tax advantaged savings accounts primarily designed for retirement, some of which are tied to employers, but the majority of which (typicallly the Traditional IRA and the Roth IRA) are not. The Roth IRA will be covered in an upcoming entry; the focus of this article will be the Traditional IRA. In the United States, Traditional IRAs can be opened by anyone with earned income; Traditional IRA holders can contribute any amount up to either the amount they earned for the year or $4,000.00, or $5,000.00 if you are 50 or above for calendar year 2007 (contributions can be made until April 15, 2008); in 2008, the limits go to $5,000.00 and $6,000.00. You can have both a Traditional and Roth IRA (or even multiple ones of each) but the amount contributed for 2007 must total no more than $4,000.00 or $5,000.00 depending on your age.
For some but not all taxpayers, the Traditional IRA will allow contribution of pre-tax dollars, allowing the amount contributed to be deducted from your gross income for tax purposes. Once in the IRA, the money can collect interest, capital gains, or dividends without taxes being deducted until distributions are withdrawn from the account after age 59 1/2; distributions withdrawn prior to age 59 1/2 are subject to penalty (with some exceptions). For taxpayers who do not qualify for the Roth IRA, the Traditional IRA can be a huge benefit. Also, for those who leave jobs where they have accumulated money in a 401(k) or 403(b) plan, those plans can be “rolled over” into a Traditional IRA with no tax penalty for the account holder and then be directed by the account holder within the limits of the IRA plan into which it is rolled over. If the account holder ends up in a lower tax bracket in retirement than when working, the traditional IRA may hold benefits over the Roth IRA, but that is a very difficult thing to predict while working.
While the Roth IRA (which is funded with post-tax rather than pre-tax dollars but allows its distributions to be withdrawn tax free provided all the rules are followed) has stolen some of the thunder of the traditional IRA over the years, the Traditional IRA is still useful for rollovers and those who are ineligible for the Roth IRA. Keep this choice in mind while deciding on investment options for yourself; it may not be your first choice, but it definitely is -a- choice.
