Traditional IRAs

IRAs, or individual retirement arrangements, are designed to help you save for retirement without the help of your employer. You can set one up yourself, and can contribute to it -- within certain limits -- even if you already contribute to a work plan like a 401(k).

A traditional IRA is a tax-deferred retirement savings account. You pay taxes on your money only when you make withdrawals in retirement.

Contributions:

If you (or your spouse) earn taxable income and are under age 70 ½, you can contribute. The limits for 2015 are $5,500, or $6,500 if you're age 50 or older.

However, whether your contributions are tax deductible depends on your income and whether you have access to a work-related retirement account.

Deductible vs. nondeductible:

A traditional IRA comes in two varieties: deductible and nondeductible. To see if you qualify for a deductible IRA, which lets you deduct all or part of your contributions from your taxable income, use the following guidelines:

  • If you have no retirement plan at work and you're under 70 ½, you can invest in a deductible IRA and deduct the entire amount from your taxes.
  • If you have a 401(k) or other retirement plan at work, you may fully or partially deduct your contribution only if your adjusted gross income (AGI) qualifies. For 2015, the deductions are phased out entirely for singles earning over $71,000 or couples earning over $118,000.
  • If you're not covered by a retirement plan, but your spouse is, you may qualify for a full or partial deduction if you file jointly and your AGI is below $193,000 for the 2015 tax year. (The same rule applies if you're a non-working spouse of someone covered by a retirement plan at work.)

If you're not eligible to contribute to a deductible IRA, you may be eligible to contribute to a Roth IRA if your AGI is below $131,000 if you're single or $193,000 if you're married and filing jointly.

If you make too much to qualify for a Roth IRA and are not eligible for a deductible IRA, a nondeductible IRA is a valid option. Your contribution won't be deductible, but at least your savings will grow tax-deferred.

So which IRA is best for you? The nondeductible is the least attractive, so open one only if you don't qualify for the other two. If you have a traditional IRA, you may want to consider converting it to a Roth, especially if you made non-deductible contributions.

Advantages:

A traditional IRA offers tax-deferred growth, meaning you pay taxes on your investment gains only when you take the money out and, if you qualify, your contributions may be deductible. Deferring taxes means all of your dividends, interest payments and capital gains can compound each year without being hindered by taxes -- allowing an IRA to grow much faster than a taxable account.

Drawbacks:

Though the money grows tax free while it's in the account, you'll have to pay taxes on any amount you withdraw. If you are under age 59 ½ when you make the withdrawal, you will also be charged a 10% penalty in addition to paying regular income taxes. So making an early withdrawal is almost always a terrible idea.

Plus, you must start making withdrawals called "required minimum distributions" after you reach age 70 ½, and you won't be able to make any additional contributions.

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