What a Traditional IRA Actually Does

A Traditional IRA is a retirement savings account where the money you put in may reduce your taxable income in the year you deposit it, and the money grows without being taxed until you withdraw it in retirement. You pay income tax on the withdrawals then, when you are presumably in a lower tax bracket. The account itself is just a container—you choose what investments go inside it, whether that is stocks, bonds, mutual funds, or cash.

The word "traditional" distinguishes it from a Roth IRA, where deposits are made with after-tax dollars but withdrawals in retirement are tax-free. Both are individual retirement accounts, meaning they belong to one person, not a couple or a business. Both have annual contribution limits set by the IRS, which change most years.

Key Takeaways

  • Money you deposit into a Traditional IRA may reduce your taxable income for that year, lowering your tax bill now.
  • Your investments grow without being taxed each year, but you pay income tax on withdrawals once you retire.
  • You must start withdrawing money at age 73, and the IRS requires a minimum amount each year.
  • You can open a Traditional IRA at a bank, brokerage, or credit union, and you control which investments are inside it.
  • If you have a workplace retirement plan like a 401(k), the tax deduction for IRA deposits may be reduced or eliminated depending on your income.

How the Tax Deduction Works

When you deposit money into a Traditional IRA, you may deduct that amount from your taxable income on your tax return. If you earn $60,000 and deposit $7,000 into a Traditional IRA, you report only $53,000 as taxable income. This lowers your tax bill that year.

The catch: this deduction is only available if you do not have a workplace retirement plan, or if you do but your income is below certain thresholds. Those thresholds change yearly and depend on your filing status. If you are covered by a 401(k) at work and earn above the limit, you cannot deduct Traditional IRA contributions. You can still deposit the money, but it will not reduce your taxes. A tax professional or the IRS website can tell you whether you may have access to in your situation.

How Growth and Withdrawals Work

Once money is in the account, any gains—interest, dividends, capital appreciation—are not taxed each year the way they would be in a regular brokerage account. If you own a stock that doubles in value, you do not owe tax on that gain until you withdraw the money. This tax deferral is the main advantage: your money compounds without being nibbled away by annual taxes.

When you withdraw money in retirement, you pay ordinary income tax on the full amount withdrawn. If you deposited $7,000 and it grew to $25,000, you pay income tax on the entire $25,000 when you take it out. This is different from a Roth IRA, where may have access to withdrawals are tax-free.

Required Withdrawals and Age Rules

You can withdraw money from a Traditional IRA anytime, but if you withdraw before age 59½, you typically owe a 10 percent penalty on top of income tax. There are exceptions—certain hardships, first-time home purchases up to $10,000, and a few others—but the general rule is that early withdrawal costs you.

Starting at age 73, the IRS requires you to withdraw a minimum amount each year, called a required minimum distribution or RMD. The amount is calculated based on your age and account balance. If you do not take the RMD, you owe a penalty on the amount you should have withdrawn. This rule exists because the government wants to collect taxes on the money eventually.

Opening and Funding a Traditional IRA

You can open a Traditional IRA at most banks, credit unions, and brokerages. The process is straightforward: you provide your name, Social Security number, address, and employment information. There is no income limit to open one, though the tax deduction has limits as described above.

You fund it by transferring money from your checking or savings account, or by rolling over money from another retirement account like a 401(k) from a previous job. You can also have your employer deposit money directly if your workplace offers that option. Annual contribution limits are set by the IRS—for 2024, the limit is $7,000 for people under 50, and $8,000 for people 50 and older. You can contribute only up to the amount you earned that year.

Traditional IRA vs. Workplace Retirement Plans

A Traditional IRA is separate from a 401(k) or 403(b) offered by your employer. A 401(k) is a workplace plan where your employer may match your contributions, and contributions come directly from your paycheck. An IRA is something you open and manage on your own. You can have both at the same time—many people do.

If your employer offers a 401(k) with a match, it usually makes sense to contribute enough to get the full match before maxing out an IRA, because the match is assistance programs. But if your employer does not offer a plan, or you are self-employed, a Traditional IRA is a straightforward way to save for retirement with a tax advantage.

What Happens to a Traditional IRA After Death

When you die, a Traditional IRA passes to whoever you named as the beneficiary on the account. That person does not inherit it tax-free—they must withdraw the money and pay income tax on it. The timeline for withdrawals depends on whether the beneficiary is a spouse, a child, or someone else, and these rules changed in recent years. A beneficiary should speak with a tax professional about their options.

If you did not name a beneficiary, the account goes through your estate, which can be slower and more expensive. Naming a beneficiary takes minutes and avoids that process.

Frequently Asked Questions

Can I have both a Traditional IRA and a Roth IRA?

Yes. Your combined contributions to both types cannot exceed the annual limit—$7,000 for 2024 if you are under 50—but you can split that between them however you want. Some people use both to diversify their tax situation in retirement.

What if I contribute to a Traditional IRA but cannot deduct it?

The money still grows tax-deferred inside the account. When you withdraw it, you pay tax only on the gains, not on the original deposit you already paid tax on. This is called a non-deductible contribution, and you must file Form 8606 with your tax return to track it.

Can I withdraw money before 59½ without a penalty?

Penalties apply to most early withdrawals, but exceptions exist: first-time home purchase (up to $10,000 lifetime), medical expenses above a threshold, health insurance premiums while unemployed, and a few others. The IRS also allows a special withdrawal method called SEPP that lets you take regular payments without penalty before 59½, though the rules are strict.

What is the difference between a Traditional IRA and a SEP IRA?

A SEP IRA is designed for self-employed people and small business owners. It allows much higher annual contributions—up to 25 percent of net self-employment income, with a much higher ceiling than a regular IRA. If you are an employee, you cannot open a SEP IRA; your employer would set one up for you.

Do I have to invest the money in stocks?

No. You can hold stocks, bonds, mutual funds, exchange-traded funds, or even cash in a Traditional IRA. Some banks offer IRA savings accounts that work like regular savings accounts but with the tax advantages. The choice depends on your risk tolerance and how long until you retire.