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Thursday, December 17, 2020

Traditional IRA


Contribution Limits

The contribution limit is currently $6,000 per year, or the amount of your earned income, whichever is less.  That's how much you are allowed to deposit into the account yourself.  It doesn't include earnings (growth from the investments held in the account) or rollovers (transfers from other accounts).  The limit is shared between Traditional IRA and Roth IRA, so if you contribute the maximum to one, you won't be able to contribute any to the other that year.

Although you contribute after-tax dollars, depending on circumstances you may be able to claim a tax deduction on your contributions which then makes it before-tax money.

Income Limits

You can contribute the maximum regardless of income.  However, if you earn more than $75,000 (year 2020) and your employer offers a 401(k) plan, you won't be able to claim a tax deduction for your Traditional IRA contributions.  If your employer does not offer a 401(k) plan, then you can claim the deduction no matter your income.

Whether you can claim the deduction or not determines whether your contributions are pre-tax or post-tax money.  If your contributions are not deductible, it is better to use a Roth IRA if you are eligible.

Tax Benefits

Traditional IRA accounts are funded with pre-tax dollars (you make deposits using money withheld from your paycheck).

Traditional IRAs grow tax-free.

Traditional IRA accounts are taxed as income when you withdraw money. If you make the unfortunate mistake of withdrawing before age 59-and-a-half, you'll have to pay an additional 10% penalty on top of the taxes!  (Do not ever do this if you can avoid it)

Recommended Providers

Vanguard is a great choice for low expense funds, and easy rollovers.

Recommended Investments

Index funds set the standard because of the ultra-low expense ratios.  Select a few index funds that diversify you across domestic and foreign markets, both stocks and bonds.  Or, choose a target date fund that does th

Target date funds are a great way to have a mix of index funds and bonds that gradually shifts towards the safety of bonds as you get older.

Advanced Strategies

If your Traditional IRA contributions are not deductible, it is better to use a Roth IRA if you are eligible.  However, if you are not eligible, you may still be able to do a Backdoor Roth Conversion.