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July 24, 2007

What is a Traditional IRA?

Posted in: Retirement Investing

A Traditional IRA (Individual Retirement Arrangement) is one of the most popular methods Americans use to save for retirement since it is an extremely versatile and simple. A Traditional IRA is a personal savings plan that gives you tax advantages for setting aside money for retirement. Taxpayers want to invest in an IRA, but when it comes to understanding which one is best for them and why, they are unsure. The information provided below will help you decide if a traditional IRA is right for you.

Tax Benefits

In the Traditional IRA,  all investments grow tax-deferred until they are removed from your account, meaning you are able to invest more of your money over the life of the IRA since they are paid with before-tax dollars.  Tax deffered means that the earnings in your Traditional IRA are not taxed until funds are withdrawn from your account.  Any IRA 401(k) contributions you  make to a Traditional IRA are typically fully deductible, but at least partially deductible, depending on your situations.  Taxable distributions may be taken without penalty starting at age 59½ and must be started by April 1st once you have reached 70½. 

Contribution Amounts

In previous years, each participant under the age of 50 in a Traditional IRA had contribution limitations of $3,000, but that amount has been increasing over the past few years. This is to help aid participants in being able to invest enough money for retirement with ever increasing costs and inflation. All participants over the age of 50 have higher contribution limitations as a ”catch up” benefit. For more information on your contribution limitations, see the chart below.

Traditional IRA Contribution Limitations
Year Age 49 & Below Age 50+
2002 – 2004 $3,000 $3,500
2005 – 2007 $4,000 $4,500
2008 - ? $5,000 $6,000

The key benefit of a Traditional IRA is tax-deferred growth.  Money invested in a Traditional IRA is pre-tax money, and therefore allows you to invest more of your hard earned money to save for retirement. You will want to review your situations before deciding if a Traditional or a Roth IRA is right for you. To compare the benefits of each, see my post on the subject, Invest in a Traditional IRA or a Roth IRA?, or my post describing the Roth IRA called, What is a Roth IRA?

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