Traditional Individual Retirement Accounts, called Traditional IRAs (or often just IRAs for short), are retirement plans that you can set up on your own, whether or not you participate in other, employer-sponsored retirement accounts.
How Traditional IRAs Work
Unlike 401(k)s, 403(b)s, and 457(b)s, traditional IRAs are retirement accounts that you set up directly with a bank, a financial services firm, or an online brokerage. Even though you’re not tied to an employer with IRAs, they do have various contribution limits based on your annual income. Here’s a quick breakdown of how they work:
You set up an IRA account: The setup process usually involves filling out a few simple forms and providing an initial deposit of $500–1,000, though some IRAs have initial deposit requirements of $25 or less. I set mine up with Scottrade.
You make contributions: You can contribute to your account at any time during the year up to the allowable limit and before the annual contribution deadline. Certain contributions can be tax-deductible, though restrictions apply (see Key Traits of Traditional IRAs below).
Your investments will grow tax-deferred which means that you don’t pay taxes on investment gains until you withdraw your assets, either after age 59 1/2 or for other qualified exceptions.
You withdraw your money after age 59 1/2: Any investment gains that you withdraw after age 59 1/2 are subject to income tax based on your tax bracket at the time at which you make the withdrawals.
Key Traits of Traditional IRAs
Tax benefits of traditional IRAs
Contributions are tax-deductible unless you’re eligible to enroll in an employer-sponsored retirement plan and your 2012 income exceeds $56,000–66,000 (for single filers) or $90,000–110,000 (for married couples filing jointly). If you have income within these ranges, you may qualify for a reduced deduction. If you’re not eligible for an employer-sponsored plan, you can deduct your IRA contributions regardless of your income level. Once you make contributions, they grow tax-deferred until withdrawal, when taxes become due.
Eligibility with traditional IRAs
If you’re under age 70 1/2, you can set up a Traditional IRA as long as you have enough earned income that year to meet the minimum initial contribution requirement.
Vesting with traditional IRAs
All contributions vest immediately.
Enrollment deadlines for traditional IRAs
A Traditional IRA for a given year must be set up by April 15 of the following year.
Contribution deadlines for traditional IRAs
All contributions to an IRA for a given year must be made by April 15 of the next year.
Contribution limits of traditional IRAs
Up to $5,000 per year or, if you’re age 50 or older, up to $6,000.
Contribution sources of traditional IRAs
Earned income (salary, commissions, other work-related sources, alimony).
Withdrawal penalties of traditional IRAs
A 10% penalty applies to withdrawals made prior to age 59 1/2. Exceptions include death, disability, higher education expenses, and the purchase of a first home.
Transferring a traditional IRA
Most plans can be transferred to other Traditional IRAs or other (pret-ax) retirement plans.
Borrowing from a traditional IRA
Loans from IRA accounts are not permitted.
Beneficiaries in a traditional IRAs
You can designate both primary and contingent beneficiaries.
Required minimum distributions of traditional IRAs
After 70 1/2, you’re required to begin withdrawing certain minimum annual amounts as of April 1 of the year after you turn 70 1/2.
Fees and minimums of traditional IRAs
Annual fees range from $0–50. Minimums range from $0–25, depending on the plan provider. However, Scottrade has no fee IRAs and you can easily use them to purchase commission free exchange traded funds.