Practically anyone can open and contribute to a traditional IRA. You can contribute the maximum allowed each year as long as your taxable compensation for the year is at least that amount. If your taxable compensation for the year is below the maximum contribution allowed, you can contribute only up to the amount that you earned.
Your contributions to a traditional IRA may be tax deductible on your federal income tax return. This is important because tax-deductible (pre-tax) contributions lower your taxable income for the year, saving you money in taxes. If neither you nor your spouse is covered by a 401(k) or other employer-sponsored plan, you can generally deduct the full amount of your annual contribution. If one of you is covered by such a plan, your ability to deduct your contributions depends on your annual income (modified adjusted gross income, or MAGI) and your income tax filing status:
For 2021, if you are covered by a retirement plan at work, and:
- Your filing status is single or head of household, and your MAGI is $66,000 or less, your traditional IRA contribution is fully deductible. Your deduction is reduced if your MAGI is more than $66,000 and less than $76,000, and you can’t deduct your contribution at all if your MAGI is $76,000 or more.
- Your filing status is married filing jointly or qualifying widow(er), and your MAGI is $105,000 or less, your traditional IRA contribution is fully deductible. Your deduction is reduced if your MAGI is more than $105,000 and less than $125,000, and you can’t deduct your contribution at all if your MAGI is $125,000 or more.
- Your filing status is married filing separately, your traditional IRA deduction is reduced if your MAGI is less than $10,000, and you can’t deduct your contribution at all if your MAGI is $10,000 or more.
For 2021, if you are not covered by a retirement plan at work, but your spouse is, and you file a joint tax return, your traditional IRA contribution is fully deductible if your MAGI is $198,000 or less. Your deduction is reduced if your MAGI is more than $198,000 and less than $208,000, and you can’t deduct your contribution at all if your MAGI is $208,000 or more.
What happens when you start taking money from your traditional IRA? Any portion of a distribution that represents deductible contributions is subject to income tax because those contributions were not taxed when you made them. Any portion that represents investment earnings is also subject to income tax because those earnings were not previously taxed either. Only the portion that represents nondeductible, after-tax contributions (if any) is not subject to income tax. In addition to income tax, you may have to pay a 10% early withdrawal penalty if you’re under age 59 1/2, unless you meet one of the exceptions. You must aggregate all of your traditional IRAs — other than inherited IRAs — when calculating the tax consequences of a distribution.
If you wish to defer taxes, you can leave your funds in the traditional IRA, but only until April 1 of the year following the year you reach age 72. That’s when you have to take your first required minimum distribution (RMD) from the IRA.1 After that, you must take an RMD by the end of every calendar year until you die or your funds are exhausted. The annual distribution amounts are based on a standard life expectancy table. You can always withdraw more than you’re required to in any year. However, if you withdraw less, you’ll be hit with a 50% penalty on the difference between the required minimum and the amount you actually withdraw.
