What Is a Traditional IRA and Why do you need it?

Everyone needs to save for retirement. Yes. Even you, who plans to rely on Social Security. 

Social Security may or may not exist in the coming decades. In the best case scenario, say Social Security remains. Rising costs will make the typical Social Security check  insufficient for most post-65 year olds’ expected standard of living. 

That’s why it’s so important to have an IRA.

What’s an IRA?

To start off with, an IRA refers to an individual retirement arrangement. They started becoming popular around the time that companies started to do away with pensions.

Their most attractive benefit? IRAs are generally tax-sheltered accounts. For most people, it means that they can save money for their golden years while keeping their money away from the “grubby hands” of the federal government.

The traditional IRA was created in 1974 with the passage of the Employee Retirement Income Security Act. It can be held at a bank or a brokerage house and it can be invested in pretty much any type of security. The best aspect of a traditional IRA is the ability to deduct your annual contributions from your taxes.

However, how much you are able to deduct from your taxes depends on your income, filing status and the availability of retirement plans at your particular job. As with any tax-deferred plan, there are advantages and disadvantages.

Traditional IRA, Roth IRA. What’s the diff?

A traditional IRA is somewhat different from a Roth IRA. Roth IRAs are much newer and very popular since they started to make their appearance. Here is how a traditional IRA differs from a Roth IRA.

Once you start to withdraw money from your traditional IRA, you will most likely be taxed on that income. That means that you will be taking a hit to your income when you are retired and more financially vulnerable than you are when you are working. Roth IRAs are funded by after-tax dollars, so you will not be taxed when you start withdrawing.

Wait, there’s a time limit?

Yes. One thing that surprises people a lot is that IRAs have a time limit. You have to start withdrawing funds from your traditional IRA at 70 and a half. If you do not take the minimum distribution required by law, you will most likely be slapped with a whopping 50% penalty on what you do not withdraw. And, if you are still working at 70 and a half, you will have that withdrawal added to your annual income, which could bump you up to a higher tax bracket than you were expecting.

While a Roth IRA might be looking like the better alternative at this point, there are some restrictions. There are income limits for Roth IRAs that limit your eligibility.

It would be outside the scope of this article to provide the entire list of limitations. So you can visit the income limits list here.

Wrapping up: Here’s the top reason why you should go for a traditional IRA 

The best aspect of a traditional IRA is that you’re investing untaxed money.

By using pre-tax dollars, you can increase the amount of money available to invest, which means bigger gains on the back end due to compound interest.

This would often be the deciding factor for high-income individuals. It should be the deciding factor to you too.

Sure, you do get taxed eventually. But that’s when you’re older and much more likely to be in a lower tax bracket.

Also, you can protect your IRA from creditors if you have to expose yourself to bankruptcy. But you cannot use your IRA as collateral if you are looking for a loan. That is a quick look at the advantages and disadvantages of a traditional IRA. Happy investing.

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