A traditional IRA is a retirement savings account where you contribute money that may reduce your taxable income in the year you contribute it

A traditional IRA is an individual retirement account you open with a bank, brokerage, or credit union. You put money in, and that money can grow through interest, dividends, or investment gains until you withdraw it in retirement. The key feature is the tax break: contributions you make may be tax-deductible in the year you make them, which means you report less income to the IRS and may owe less in taxes that year.

The tradeoff is that when you withdraw money in retirement, those withdrawals are taxed as ordinary income. You also cannot touch the money penalty-free before age 59½ in most cases. The account itself does not charge you to hold it — the cost comes from the taxes you will owe later and any investment fees your provider charges.

Key Takeaways

  • Contributions to a traditional IRA may reduce your taxable income in the year you contribute, but withdrawals in retirement are taxed as ordinary income.
  • You cannot withdraw money before age 59½ without paying a 10% penalty plus income tax on the amount withdrawn, with limited exceptions.
  • Annual contribution limits are set by the IRS and change year to year; you cannot contribute more than you earned that year.
  • You must begin taking required minimum distributions at age 73, and the IRS will charge a 25% penalty on any amount you fail to withdraw.
  • A traditional IRA is different from a Roth IRA, which uses after-tax contributions but allows tax-free withdrawals in retirement.

How the tax deduction works and who can claim it

When you contribute to a traditional IRA, you may deduct that contribution from your income on your tax return. If you earned $60,000 and contributed $7,000 to a traditional IRA, you would report $53,000 in taxable income instead. This lowers your tax bill that year.

However, the deduction phases out if you or your spouse has a workplace retirement plan (like a 401(k)) and your income is above a certain threshold. The income limits change each year. If you have no workplace plan, you can deduct the full contribution no matter how much you earn. If you do have a workplace plan, the IRS website publishes the current year's income limits, and your tax software will calculate whether you can deduct the full amount, part of it, or none of it.

Contribution limits and how much you can put in each year

The IRS sets an annual limit on how much you can contribute to a traditional IRA. For 2024, that limit is $7,000 if you are under age 50, and $8,000 if you are 50 or older (the extra $1,000 is called a "catch-up" contribution). These limits change periodically, and you can find the current year's limit on the IRS website.

You cannot contribute more than you earned in that year. If you earned $5,000 in 2024, you can contribute at most $5,000 to a traditional IRA, even though the limit is $7,000. If you are married and file jointly, you can each open your own IRA and each contribute up to the limit, as long as your household earned at least that much combined.

Withdrawals before retirement and the 10% early withdrawal penalty

If you withdraw money from a traditional IRA before age 59½, you owe income tax on the amount withdrawn plus a 10% early withdrawal penalty. A $10,000 withdrawal at age 45 would trigger $1,000 in penalties alone, plus income tax on the full $10,000.

There are exceptions to this penalty. You can withdraw without penalty if you are disabled, if you use the money for may have access to medical expenses that exceed 7.5% of your adjusted gross income, if you are unemployed and using it for health insurance premiums, or if you are a first-time homebuyer withdrawing up to $10,000 for a down payment. You still owe income tax on the withdrawal in these cases — the penalty is waived, but the tax is not. The IRS publishes the full list of exceptions, and your tax preparer can tell you whether your situation qualifies.

Required minimum distributions starting at age 73

Once you reach age 73, the IRS requires you to withdraw a minimum amount from your traditional IRA each year, whether you need the money or not. This amount is calculated by dividing your account balance by a life expectancy factor the IRS provides. If you fail to take the required withdrawal, the IRS charges a 25% penalty on the amount you should have withdrawn.

You must take your first required minimum distribution by April 1 of the year after you turn 73. After that, distributions are due by December 31 each year. If you have multiple IRAs, you can add up the required amounts and withdraw from one account, or you can withdraw from each account separately — the choice is yours. Your IRA provider will usually calculate the required amount for you and send you a notice.

Traditional IRA versus Roth IRA: the main differences

A Roth IRA works differently in two important ways. With a Roth, you contribute money that has already been taxed (no deduction), but withdrawals in retirement are tax-free. With a traditional IRA, you get a tax deduction now but pay tax on withdrawals later.

Roth IRAs also have no required minimum distributions — you can leave the money in the account as long as you want. Traditional IRAs require you to start withdrawing at 73. Roth contributions have income limits (you cannot contribute if you earn above a certain threshold), while traditional IRA contributions have no income limit, though the deduction phases out. The choice between them depends on whether you expect to be in a higher or lower tax bracket in retirement, and how long you want to keep the money invested.

How to open a traditional IRA and where to hold it

You can open a traditional IRA at any bank, credit union, brokerage firm, or investment company. Common providers include Fidelity, Vanguard, Charles Schwab, and your own bank. The process is usually online and takes 10 to 15 minutes. You will need your Social Security number, a valid ID, and a funding source (a checking account to transfer money from, or a check to mail in).

Once the account is open, you decide what to invest the money in. Some IRAs hold cash in a savings account earning interest. Others hold stocks, bonds, mutual funds, or exchange-traded funds (ETFs). Your provider will show you the investment options available. You are not required to invest in anything — you can leave the money in cash if you want, though it will earn very little. The fees vary by provider and by what you invest in; some charge annual account fees, and some charge per-transaction fees or fund expense ratios.

Frequently Asked Questions

Can I have both a traditional IRA and a 401(k) at the same time?

Yes. You can contribute to both in the same year, but your traditional IRA deduction may be limited if you have a 401(k) and earn above the income threshold. The 401(k) contribution limit and the IRA contribution limit are separate, so you could contribute $23,500 to a 401(k) and $7,000 to a traditional IRA in 2024, as long as you earned enough and your employer plan allows it.

What happens to my traditional IRA if I die?

Your beneficiary (the person you name when you open the account) inherits the IRA. They can roll it into their own IRA, take the money out, or leave it invested. The rules for inherited IRAs changed in 2023, and most non-spouse beneficiaries must now withdraw the entire balance within 10 years. Your IRA provider can explain the options to your beneficiary when the time comes.

Can I withdraw money to pay off debt or buy a car?

You can, but you will owe the 10% early withdrawal penalty plus income tax on the full amount. A $15,000 withdrawal at age 40 would cost you $1,500 in penalties plus income tax, so you would net less than $13,000. It is usually cheaper to borrow money another way or to wait until age 59½ to withdraw.

What if I contribute too much to my IRA by accident?

If you over-contribute, you can withdraw the excess and any earnings on it before your tax return deadline (usually April 15 of the following year) to avoid penalties. If you do not catch it in time, the IRS charges a 6% penalty on the excess amount each year it remains in the account. Contact your IRA provider immediately if you think you have over-contributed.

Do I need to report my IRA on my tax return?

Yes. You report contributions on Form 1040 to claim the deduction, and you report distributions on Form 1099-R, which your IRA provider sends you. If you have a traditional IRA and a Roth IRA, you may need to file Form 8606 as well. Your tax software or tax preparer will guide you through this.