What is a Traditional IRA?

//What is a Traditional IRA?
What is a Traditional IRA? 2017-10-10T16:54:02+00:00

Definition: A Traditional IRA or Individual Retirement Account is a tax-deferred savings account that an individual deposits pre-tax contributions in and can withdrawal the funds after the age of 59.5. These withdrawals are then treated as ordinary income.

What Does Traditional IRA Mean?

What is the definition of traditional IRA? It is an account that has tax advantages and encourages people to save for retirement. IRAs can be inherited and money/property can be transferred to and from the IRAs. These accounts can have other types of securities invested like certificates of deposit, stocks, and mutual funds. In order to qualify for a Traditional IRA you must have sufficient income to be able to contribute.

Taxes on withdrawals from this account must be paid before the withdrawn funds are used, so it is not ideal for emergency situations. The tax benefits can be considered a loan because eventually they will have to be paid back when the funds are withdrawn.

Individuals are legally allowed to withdrawal funds at any time before the age of 59.5, but they will have to pay a 10% penalty plus the income taxes on the funds. There is no penalty for withdrawals after the age of 59.5 and account owners must begin taking their money out of the account by age 70.5 or late penalties will apply.

Let’s look at an example.

Example

Lawrence made $40,000 during the year. He decided to put $4,000 of it into an IRA. His income tax would only be taken out on the $36,000 that wasn’t deposited in the IRA. If he decided to make this a yearly habit, his saving would continue to grow free of tax. In other words, he won’t pay taxes on the interest his IRA makes each year until he finally withdrew the money for his retirement after age 59.5. Upon withdrawal, the money would be taxed as regular income according to the income tax rate depending on the amount withdrawn.

Penalties sometimes apply. If Lawrence were to withdraw the funds before age 59.5, he’d have to pay not only the income tax but a 10% penalty the total amount in the account. There are a few exceptions like if the withdrawal was for the purpose of qualified higher education expenses or one of other eight exceptions, then the penalty will be waived.

Summary Definition

Define Traditional IRAs: Traditional individual retirement account means a retirement investment account that people are allowed to contribute to pre-tax.