Traditional IRA Details

Summary

Traditional IRAs allow workers to invest earned income in a retirement savings account where it can grow through wise investments. A Traditional IRA is any IRA that is not a Roth IRA or a SIMPLE IRA. There are two basic advantages of a Traditional IRA: you may be able to deduct some or all of your contributions to it (i.e. pre-tax dollars), and the funds and any earnings are not taxed until distributed to you.

Open and make tax-deductible contributions to a Traditional IRA if:

• You (or, if you file a joint return, your spouse) received taxable compensation during the year for which you are making the contribution.
• Please note: You can now take Required Minimum Distribution FROM AND make contribution TO an IRA in the same tax year, provided you have earned income for that tax year. 

More on Contribution Limits 

You can contribute to a Traditional IRA whether or not you are covered by any other retirement plan. For spouses filing jointly, only one need have compensation for both to contribute to an IRA. Generally, compensation is income you earn from working.

The trustee or custodian must be an entity approved by the IRS to act as trustee or custodian, such as a trust company or bank. Contributions must be in cash, although once funded, the IRA can invest the cash in alternative assets. You may also roll over such assets from another qualified plan into your IRA.

Contributions

Contributions towards your IRA’s annual limit can be made at any time during the year up until the due date for filing your tax return for that year, not including extensions. In general, contributions to your Traditional IRA can be deducted from your taxable income for the year up to the limits defined by the IRS. If you or your spouse was covered by an employer retirement plan during the year, your contributions may be reduced or eliminated, depending on your filing status and income.

More on Contribution Limits

Transfer IRA Assets

You can transfer assets tax-free (money or property) from other retirement programs to a Traditional IRA using one of three methods:

• Transfers from one trustee to another
• Rollovers
• Transfers incident to a divorce

Required Minimum Distributions

You cannot keep funds in a Traditional IRA indefinitely. You must begin taking Required Minimum Distributions according to a schedule provided by the IRS. If you do not take Required Minimum Distributions, or if the distributions are not large enough, you may have to pay a 50% excise tax on the amount not distributed as required.

More on Required Minimum Distributions 

Penalties and Additional Taxes

The advantages of using Traditional IRAs can be offset by additional taxes and penalties if you do not follow the rules. You are penalized for using IRA funds in prohibited transactions and other activities.

Generally, a prohibited transaction is any improper use of your Traditional IRA by you, your beneficiary, or any disqualified person. Disqualified persons include your fiduciary and members of your family (spouse, ancestor, lineal descendant, and any spouse of a lineal descendant). A fiduciary is anyone who does any of the following:

• Exercises any discretionary authority or discretionary control in managing your IRA or exercises any authority or control in managing or disposing of its assets
• Provides investment advice to your IRA for a fee, or has any authority or responsibility to do so
• Has any discretionary authority or discretionary responsibility in administering your IRA

The following are examples of prohibited transactions within a Traditional IRA:

• Borrowing money from it
• Selling property to it
• Receiving unreasonable compensation for managing  it
• Using it as security for a loan
• Buying property for personal use (present or future) with IRA funds

Generally, if you or your beneficiary engages in a prohibited transaction in connection with your IRA at any time during the year, the account stops being an IRA as of the first day of that year.

Early Distributions

You must report taxable early distributions (before you are age 59 ½) from your Traditional IRA in that year’s gross income and pay a 10% tax in addition to any regular income tax owed.

However, there are exceptions for first time home purchases, qualified medical expenses and disaster-related expenses. The SECURE ACT, which became effective January 1, 2020, and the CARES Act, which became effective March 27, 2020 in response to the Corona-virus pandemic, and expanded the circumstances in which such early distributions may be made.

More on the SECURE and CARES Act 

Disclaimer

The content provided on this page is for informational purposes only and does not constitute a complete analysis of the rules governing the creation and use of a Traditional Individual Retirement Account (IRA).  It is intended to provide an overview only of the benefits, eligibility requirements, and funding limitations of Traditional IRAs. For complete details regarding this type of savings plan, including definitions of a qualified compensation, distributions, and tax reporting, refer to IRS Publication 590.