Tax Benefits of a Traditional IRA

What is a traditional IRA? 

A traditional IRA, or individual retirement account, is an investment account with specific tax benefits designed to help you save more for retirement. You can contribute pre-tax, post-tax, or a combination of both types of income to a traditional IRA.

If your household income is below the IRS-defined income limits for the year, you can usually reduce your taxes by deducting all, or a portion, of your annual contributions or choose to deduct only a portion.

Because you won’t pay tax on any earnings in your IRA until you withdraw money, your savings has the potential to grow tax-free until you retire. Since your income is likely to be lower in retirement, you’ll probably get taxed at a lower rate than you would today.

Post-tax contributions are taxed the year you contribute them, so they are generally not taxed when you withdraw them.

Advantages of a traditional IRA 

The main advantage of a traditional IRA is that it can deliver tax benefits while helping you save more money for retirement. More specifically:

You may get an income tax deduction. If you meet the IRS income limits, you can deduct all or part of your annual IRA contributions from your taxable income. This may lower your tax bill or increase your refund.
Your investments can grow tax-free. You don’t pay taxes on any earnings from your pre-tax contributions until you withdraw the money. This can help your savings grow more than it would if you were paying taxes along the way.
You can invest your money how you want. The IRS lets you invest your money in stocks, bonds, mutual funds, exchange-traded funds (ETFs), and even CDs and cash.
There are no income limits: You can contribute to a traditional IRA no matter how much earned income you have. (Earned income is income you get from a job, including wages, salaries, tips, bonuses, and self-employment income.)
You can use the money for education or a new home before you retire. While the traditional IRA is intended for retirement savings, you are allowed to withdraw money penalty-free for qualified education expenses or purchasing your first home. If you withdraw money for reasons other than these (and some other, less common exceptions) before age 59 ½, you may face an additional 10% tax on the amount distributed.

Traditional IRA vs. Roth IRA 

A Roth IRA is another type of individual retirement account with its own unique structure and advantages. Both accounts can help you save for retirement. There are three important differences:

Eligibility: Anyone with earned income can make contributions to a traditional or Roth IRA. See “What’s New?” in IRS Publication 590A for the 2024 contribution limits for both types of IRA. Taxpayers who are age 73 or older must start (or continue) taking required minimum distributions (RMD) from their traditional IRAs even if they are still working.
Tax benefits today: You may be able to take a tax deduction for your traditional IRA contributions. However, you cannot deduct contributions to a Roth IRA.
Tax benefits in retirement: Withdrawals from a traditional IRA are fully or partially taxable. Withdrawals from a Roth IRA are completely tax-free.

Is a traditional IRA better than a 401(k)? 

Many people save for retirement in a 401(k) plan. A 401(k) is an employer-sponsored plan that allows you to contribute some of your earnings directly to your account and reduce your taxable wages.

Whether a traditional IRA or a 401(k) makes more sense for you depends on your specific situation. Some important differences to consider are:

	Traditional IRA	Traditional 401(k)
Eligibility	Available to everyone with earned income regardless of age.	Only available through your employer (if they offer it) regardless of age.
2023 contribution limits	Up to $6,500 if you are under age 50, and an additional $1,000 if you are age 50 or older.	Up to $23,000 if you are under age 50, and an additional $7,500 if you are age 50 or older. Contributions are often deducted directly from your paycheck.
Employer contributions	Not available.	Employers can add up to $46,000 to your 401(k) savings by matching some or all of your contribution. This brings the total allowed contributions up to $69,000 ($76,500 if 50 or older).
Tax benefits	Contributions to a traditional IRA may be tax-deductible, depending on your income level and participation in an IRA.	Your contributions to a 401(k) are typically withheld from your taxable income by your employer, effectively reducing your tax burden. Employer contributions are also not added to taxable income.
Investment choices	Usually flexible, with access to a wide range of assets.	Usually flexible but depends on the plan administrator’s available options.

Who can invest in a traditional IRA? 

Anyone at any age who has an earned income can make annual contributions to a traditional IRA. Keep in mind that the IRS sets income limits for the amount of your contributions.

How to open a traditional IRA? 

You can open a traditional IRA at many banks, mutual fund companies, and brokerage firms.

How much money can you contribute to a traditional IRA? 

IRS rules and regulations determine how much you can contribute to IRAs and other types of retirement accounts. The 2024 contribution limit for a traditional IRA is $7,000 if you are under age 50, and up to $8,000 if you are age 50 or older.

Be sure to check the contribution limits every year. The IRS often adjusts them due to inflation.

heck the contribution limits every year. The IRS often adjusts them due to inflation.

Questions? Jackson Hewitt Tax Pros can help you understand how investing in a traditional IRA could affect your annual tax refund or payment.

The benefits of a traditional IRA