Nearly anyone with taxable compensation, who is under the age of 70 ½, may open and contribute to a Traditional IRA. Annually, individuals are allowed to make contributions of up to $5,500 (or $6,500 for those over age 50). However, the amount of the contribution must not exceed the total amount of a person’s taxable compensation. Individuals may only contribute up to the amount they earn.
Contributions to Traditional IRAs are deductible on Federal Income Tax returns. As a result, those contributing to traditional IRAs save money because their contributions lower their overall taxable income for the year. This makes a traditional IRA a good tool for those looking to lower their annual tax bill while they are employed. IRA contributions are fully-deductible if neither an individual, or his or her spouse, is covered by a 401(k) plan or another employer-sponsored plan. If other plan coverage exists, the deductible amount is dependent upon a person’s Modified Adjusted Gross Income and his/her income tax filing status. Based on these factors, a person may qualify for a full deduction, a partial deduction or no deduction.
Distributions from traditional IRAs are subject to income tax since the initial contributions weren’t taxed at the time they were made. In additions, any portion of the IRA that represents investment earning is also subject to income tax since those earnings weren’t previously taxed. Only the portion of the IRA account that represents non-deductible, after-tax contributions isn’t subject to income tax. Those who withdraw funds prior to age 59 ½ may also be required to pay a 10% early withdrawal penalty, unless they meet one of the exceptions below:
In order to defer taxes, individuals may leave funds in their traditional IRAs until April 1 of the year following the year they turn 70 ½. At this time, the first distribution from the IRA is required, and individuals must take a distribution at the end of every calendar year until their funds are exhausted or they become deceased. Traditional IRA holders may always withdraw more than they are required to annually, but taking out less than required may result in a 50% penalty on the difference between the required minimum withdrawal and the amount actually withdrawn.