A traditional IRA is a popular vehicle for retirement planning and investing. Tax-deductible contributions, tax-deferred growth, and a wide array of investment options are some of the benefits that make the traditional IRA so attractive.
Overview of a Traditional IRA
A traditional IRA is a type of account used by individuals for retirement investing. If you own an IRA, you can contribute money up to a certain annual limit to your account, while deducting the contributions from your taxable income. Your money grows on a tax-deferred basis, and you can start withdrawing money from your account without penalty once you reach retirement age.
Planning for Retirement with your IRA
There are some important things to keep in mind when using an IRA for retirement planning.
First, consider the tax treatment of traditional IRAs. As mentioned previously, IRA contributions are tax-deductible. Any withdrawals you take from your IRA are subject to income tax, and if you take withdrawals prior to reaching age 59 ½, a 10% IRS penalty will apply.
Given the penalty for premature withdrawals, it is important that you only allocate money to your IRA that you are certain you won’t need until retirement.
There are also limits to how much you can contribute to an IRA. Currently, this is $5,500 per year if you are under age 50 and $6,500 if you are 50 or older.
One of the most important aspects of an IRA is how you allocate the account’s assets. Younger investors will typically have a more aggressive portfolio, as their long time horizon can withstand market fluctuations, while those closer to retirement will usually have a more conservative allocation.
IRA Investment Options
The underlying investments in your IRA will determine how the account will perform. There are many different investment options available for your IRA, but here are some of the most common:
- Equities –Stock shares of publicly traded companies
- Bonds – Corporate and government-issued debt securities
- Mutual Funds/Exchange-traded Funds (ETFs) – Professionally managed investment portfolios that invest in a certain sector or track the performance of an index (such as the Dow Jones Industrial Average or the S&P 500)
- Annuities – Variable, fixed, and indexed insurance contracts, which can be turned into a stream of guaranteed lifetime income
The traditional IRA is the most popular type of IRA, but there are a few other types as well.
- Roth IRA – Contributions to a Roth IRA are not tax-deductible, but withdrawals after age 59 ½ are completely free of taxes.
- SIMPLE IRA – A SIMPLE IRA is a type of plan that functions in a similar fashion as a 401(k). SIMPLE IRAs are employer-sponsored and may be established by employers with fewer than 100 employees.
- SEP-IRA – A Simplified Employee Pension (SEP) IRA is another employer-sponsored plan. It is adopted by self-employed business owners to benefit themselves and their employees.