What are the Qualifications for a Traditional IRA?
Traditional IRAs offer a tax-advantaged way to save for retirement. Contributions to a Traditional IRA are tax-deductible, and the earnings on investments grow tax-free. There are very few requirements to establishing a Traditional IRA, and you can control how your money is invested. Depending on your expected tax bracket in retirement, you may want to consider investing in a Traditional IRA.
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The Facts
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Anyone can open a Traditional IRA, provided they have earned income and will not turn 70 1/2 by the end of the year. Earned income includes income from employers and self-employment income, but not income from rental property, pensions or interest and dividends. You must have at least as much earned income each year as the amount you contribute to a Traditional IRA. You can open an IRA at any bank or brokerage company approved by the IRS.
Function
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As of 2009, you can contribute up to $5000 per year to a Traditional IRA. If you are over 50, you are permitted to make a "catch-up" contribution of up to $1000. These amounts are subject to change every year. Contributions to a traditional IRA are tax-deductible and are invested in vehicles like stocks, bonds and mutual funds, as you direct. Investment earnings are tax-deferred, meaning you will pay no taxes on contributions or earnings until you begin to withdraw money.
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Features
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You may open a Spousal IRA for the benefit of a non-working spouse. Rules and contribution limits are the same as for Traditional IRAs. You must begin making withdrawals from your Traditional IRA when you turn 70 1/2. You may withdraw the entire amount, or take required minimum distributions (RMD) each year. IRA distributions are taxed as ordinary income, at your current tax rate. You will pay a penalty if you fail to take the RMD in any year.
Considerations
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While subject to many of the same rules as a Traditional IRA, a Roth IRA provides an alternative means to save for retirement. Contributions to a Roth IRA are made with after-tax dollars, meaning less money in your pocket today. However, Roth IRA earnings grow tax-deferred, and withdrawals are tax-free. You are also not required to take distributions from a Roth IRA, allowing you to leave money to your heirs if you won't need the money in retirement.
Warning
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Since Traditional IRAs are intended for retirement savings, you will face penalties if you need to withdraw money before retirement. If you are under age 59 1/2, you will pay taxes on any withdrawals, in addition to a 10 percent IRS penalty. There are certain exceptions to this rule, including withdrawals for higher education expenses for yourself or your dependents, certain medical expenses or the purchase of your first home. In these cases, the early distribution penalty will be waived, although your withdrawals will still be taxed.
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