What Are the Two Types of Traditional IRAs?

What are the two types of traditional IRAs

Traditional and Roth IRAs offer tax benefits; their differences lie in how earnings are treated. Traditional IRAs may be particularly suitable for individuals expecting to enter lower tax brackets after retirement and those without access to workplace retirement plans.

Tax-deferred growth potential

IRAs provide another savings vehicle with potential tax advantages, depending on your overall financial picture. Your money grows tax deferred until distributions in retirement.

Withdrawals will then be taxed at your ordinary income rate; this is better than taking out money before retirement where taxes and penalties could come into play.

Traditional IRAs not only offer tax deferred growth, but they also provide a wide selection of investment choices. You can either select your investments yourself or utilize a brokerage that acts as custodian. For an easier approach, many robo-advisers offer target date funds which automatically select an optimal mix of stocks and bonds based on when your retirement date will occur.

The SECURE Act passed in 2019 made significant modifications to required minimum distributions (RMDs) from traditional IRAs, pushing back when you must start taking RMDs from them to age 72.

Penalty-free withdrawals

Traditional IRAs differ from employer-sponsored plans in that they permit penalty-free withdrawals under certain circumstances. You may withdraw nondeductible contributions, plus investment earnings earned in that investment account without incurring an extra 10% penalty; however, any expenses must have occurred during the same year when you made contributions.

Your traditional IRA money may also be used to cover unreimbursed medical expenses that exceed 10% of your adjusted gross income and make penalty-free withdrawals if called to active duty for more than 179 days without yet taking distributions from it.

Anyone with taxable income is eligible to contribute to a traditional IRA; however, tax deductions become less available as income increases. Self-employed and small business owners can save even more with SEP or SIMPLE IRAs; however, remember that tax is due on withdrawals in retirement; your Required Minimum Distribution (RMD) amounts will depend on how long your life expectancy lasts.

Access to a wider range of investment options

IRAs allow you to invest in various assets while taking advantage of tax-deferred growth. You may qualify for a traditional IRA if your income doesn’t qualify for a Roth IRA or have access to an employer-sponsored retirement plan such as 401(k).

Mutual funds and ETFs are among the most sought-after IRA investments, offering higher returns than savings accounts, certificates of deposit, U.S. Treasury bills or money market funds but carrying greater risks.

Small-business owners or self-employed people looking for retirement options have several options available to them, from traditional IRAs and SIMPLE/SEP IRAs, to other retirement plans like TSDP or GIFSA plans. Contributions made up to age 70 1/2 will be taxed at ordinary income rates; any distributions before age 59 1/2 could incur an early distribution penalty (subject to some exceptions).

Tax-deductible contributions

Dependent upon your income level, contributions made to traditional IRAs may qualify for tax-deferred investment growth in your account – however any withdrawals post-age 59 1/2 may incur taxes.

The IRS sets strict rules and limits on how much an IRA contribution can be each year, while if you take part in a workplace retirement plan you should consult your employer or plan administrator regarding any tax deductions available up-front for such contributions.

Self-employed and small business owners with no more than 100 employees can open a SEP IRA, while employers with fewer than 100 workers who don’t offer other retirement plans for their workers can open a SIMPLE IRA; contribution limits for SIMPLEs are higher and catch-up contributions may be permitted; however, tax deductibility of contributions decreases with income levels over time.


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