The Basics of a Traditional IRA

Planning for retirement can be intimidating, but the more you know, the better equipped you’ll be to set yourself up for success.

A traditional IRA (individual retirement account) is one of the simplest ways to prepare for your future while enjoying tax advantages along the way. 

Whether you’re just starting to save or looking to boost your existing retirement plan, understanding the basics of a traditional IRA can help you make informed financial decisions.

Here’s a quick guide to help you get started. 

Key takeaways

• Traditional IRAs may help you reduce taxable income while saving for retirement.
• Anyone with earned income, including non-working spouses, can contribute to a traditional IRA and save for their future.
• You can start withdrawing funds penalty-free at age 59½. Keep in mind that any withdrawals made prior to this age will face a 10% penalty plus taxes.

What is a traditional IRA?

A traditional IRA is a personal savings account designed to help you grow your retirement savings with tax advantages. Contributions to a traditional IRA are typically tax-deductible, meaning you may lower your taxable income. 

Money invested in a traditional IRA account grows tax-deferred. This means you won’t owe taxes until you withdraw funds during retirement.

The main advantage of this structure is that it allows you to put in more money, which grows over time, and is likely going to be taxed at a lower rate, since theoretically, you will have a lower income in retirement.

Compared to a 401(k), which is typically offered through your employer, anyone with earned income can open and contribute to a traditional IRA, regardless of employment status.

This is why IRAs are popular among self-employed individuals, freelancers, and those looking for additional ways to save for retirement. 

Traditional IRA rules

Saving for retirement comes with its own set of rules. Understanding the nuances of a traditional IRA can help you make the most of your savings. From who is eligible for a traditional IRA to how much you can save each year, these guidelines ensure you’re on track for a more secure financial future. 

Who’s eligible for a traditional IRA?

If you have earned income, you’re likely eligible to open a traditional IRA. Unlike a 401(k), which is tied to your employer, a traditional IRA is available to almost anyone.

From employees to self-employed individuals and even non-working spouses, there are opportunities for a wide range of people. 

While there aren’t any age restrictions on who can contribute, there are income limits that affect the deductibility of contributions if you or your spouse have access to a workplace retirement plan. 

Contribution limits for a traditional IRA

How much can you contribute to your IRA? Well, the IRS sets limits each year on how much you can contribute. For 2025, the maximum contribution to a traditional IRA is $7,000, plus an additional $1,000 catch-up contribution for taxpayers 50 and older. 

Keep in mind that this limit applies to the total contributions made to all of your IRAs, including traditional and Roth, for the year. 

Traditional IRA withdrawal rules

Traditional IRA rules dictate how old you have to be to withdraw money. The IRA withdrawal age, penalty-free, starts at 59½ years old. Any withdrawals made before this age may be subject to a 10% early withdrawal penalty, plus income taxes. 

There are also required minimum distributions (RMDs) that kick in once you turn 73. This means that you have to start withdrawing a minimum amount from your account each year, even if you don’t need the money. When you make these withdrawals, they’re taxed as ordinary income. 

Remember that 10% penalty for distributions from an IRA prior to age 59 ½? There are exceptions to every rule. Under certain circumstances, the penalty can be waived.

Medical expenses over 7.5% of adjusted gross income, disbursements to taxpayers living in a federally declared disaster area, first-time homebuyers, or qualified education expenses are just a few examples of circumstances in which taxpayers can avoid the penalty.

Knowing these exceptions can help taxpayers with tax planning strategies.

Is it worthwhile to invest in an IRA?

Choosing the right types of investments for your future depends on your unique financial situation and goals.

For many people, a traditional IRA offers valuable tax advantages, flexible investment options, and a way to grow savings outside of employer-sponsored plans. That said, factors like your income, access to a 401(k), and future tax expectations all play a role in determining which type of retirement account is right for you.

What are the benefits?

A traditional IRA offers an array of benefits that can help you maximize your retirement savings, including:

• Tax-deferred growth: Tax-deferred growth means that you won’t pay taxes on interest, dividends, or capital gains as long as the money stays in your account. 
• Potential tax deductions: Depending on your income and whether you have access to a workplace retirement plan, you may be able to deduct your contributions from your taxable income.
• Investment options: Unlike a 401(k), which often limits you to a set list of funds, a traditional IRA gives you access to a broader range of investment options such as stocks, bonds, mutual funds, ETFs, and other securities. 
• No income limits for contributions: Unlike a Roth IRA, there’s no income limit for making contributions. You can contribute to your IRA as long as you have earned income. 
• Flexibility and control: Since it’s not tied to an employer, a traditional IRA gives you the freedom to open an account with any financial institution. 
• Spousal contributions: If your spouse doesn’t earn income, you can still make spousal IRA contributions on their behalf, allowing couples to double their retirement savings potential. 

Are there any drawbacks?

While a traditional IRA is a powerful tool for retirement savings for most people, there are a few limitations to be aware of. Restrictions related to traditional IRA rules can impact your decision to open a traditional IRA. 

These drawbacks aren’t deal-breakers for most people, but understanding them can help you make a more informed decision. 

• Withdrawal restrictions: A Roth IRA allows you to withdraw contributions at any time, while early withdrawals from a traditional IRA before the age of 59½ are subject to a 10% penalty plus income taxes. This makes it less flexible if you need to access money before retirement. 
• Required minimum distributions (RMDs): Starting at age 73, you are required to take out minimum distributions each year. Even if you don’t need the funds, you are required to make withdrawals. This can impact your tax bill during retirement and reduce the amount of money left to grow in the account.
• Income limits for deductibility: The higher your income, the less you may be able to deduct, especially if you or your spouse has access to a workplace retirement plan like a 401(k). 
• Contribution limits: The annual contribution limit for a traditional IRA is $7,000 ($8,000 if you’re 50 or older) for 2024 and 2025. Compared to a 401(k), which has a much higher limit, the IRA’s cap on contributions may feel restrictive for high savers. 

How does a traditional IRA compare to other IRA types? Traditional IRAs are just one type of IRA available. A Roth IRA, for example, offers tax-free withdrawals in retirement but requires you to pay taxes on contributions up-front. 

A SEP IRA and a SIMPLE IRA are designed for self-employed individuals or small business owners, offering higher contribution limits but with different rules. Choosing between these accounts depends on your tax preferences, employment situation, and savings goals. 

Many people find it beneficial to have multiple types of retirement accounts, like a traditional IRA, Roth IRA, and 401(k), to diversify their tax strategy and maximize their savings potential. By understanding the pros and cons of each, you can create a more balanced approach to retirement planning.

How to open a traditional IRA

This step is simple. You can complete the process online or in person with a financial institution. The first step is to choose a provider.

From banks to brokerages or financial services companies, there are multiple options. Look for ones that offer low fees, a variety of investment options, and user-friendly account management tools. 

Once you’ve chosen a provider, you’ll need to fill out an application. After your account is set up, you can fund it by transferring money from a bank account.

The final step is selecting how you want to invest your money. Choose from stocks, bonds, ETFs, and mutual funds based on your financial goals and risk tolerance.