Traditional IRA Details
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
- You were not age 70½ by the end of the year
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 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.
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
- Transfers incident to a divorce
Required Minimum Distributions
You cannot keep funds in a Traditional IRA indefinitely. You must generally start receiving distributions from your IRA by April 1 of the year following the year in which you reach age 70 ½. If you do not make required 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.
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.
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.
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.