Q

What's a traditional IRA?

A

It's an investment account designed to help you save for retirement and save on taxes.

A Traditional IRA, which stands for “individual retirement account,” is a tax-advantaged retirement account and designed to help you save money, and earn returns, for retirement while deferring taxes. The beauty of the IRA is that it allows you to invest money “pre-tax,” which means that you can subtract the amount you contribute right off the top of your income and bring your tax bill down. For example, if you made $60,000 and you contribute $5,000 to your IRA, you’ll only be taxed on $55,000. Neat, right?

Though you will have to pay taxes on that income eventually — that’s why it’s called tax-deferred rather than tax-free. For IRAs, taxes are paid when you withdraw those funds, hopefully after retirement. One big advantage to IRAs is that, since you don’t pay taxes on the money you contribute, the government is essentially lending you money to invest with. And more money now, means even more money later thanks to compounding. Not to mention that your tax rate is usually lower when you’re retired than it was when you were working.

One IRA-related warning worth paying attention to: with a couple notable exceptions, if you withdraw the money before you hit the magic age of 59 ½, the IRS will collect the income tax on the money you withdraw, plus a 10% penalty.

You can’t contribute as much money as you want to your IRA. The IRS sets limits each year for contributions — right now it’s $5,500 annually, or $6,500 if you’re 50 or older and need to save more, or your taxable compensation for the year, if your compensation was less than this dollar limit. (And less if you’re participating in certain other types of retirement accounts - there is one combined limit for your traditional and Roth IRAs. It can’t hurt to speak to a financial advisor if you don’t know what you qualify for). And you’re free to work until you’re as old as Yoda, but the IRS does require you to start taking withdrawls from your IRA at age 70 ½.

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