Traditional IRAs are a great investment vehicle for retirement for those who qualify to contribute to them (there are some limitations), and they have some interesting features that can make them very advantageous.
Here are some of the benefits to a Traditional IRA:
- Anyone can contribute provided he/she has earned income; however, you cannot contribute more money to a than what you have in yearly earned income (ex: if you only made $4,000 for a year, you can ONLY contribute up to $4,000 in your Traditional IRA for that particular year)
- For 2016 and 2017 the annual contribution limit is $5,500 ($6,500 if you’re over age 50), and you have the freedom to invest in any type of investment you are comfortable with (stocks, mutual funds, ETFs, bonds, CDs, annuities, etc.)
- Your money grows TAX-DEFERRED (and contributions are tax-deductible) so no matter what your tax bracket is in retirement (past age 59 ½), your distributions will be taxed at that current rate (hopefully a lower rate than during your working years)
- You have until April 15th of the following year to make a yearly contribution (ex: you have until April 15th, 2017 to contribute for 2016), allowing 15 ½ months to fill your Traditional IRA up each year
- You can make non-deductible contributions and those contributions should never be taxed once withdrawn (must keep track of non-deductible contributions carefully)
- Traditional IRA rules allow you to withdraw your money out early (before age 59 ½) at any time BUT there is a 10% penalty for doing so (there are also several exceptions where the IRS will waive the 10% early withdrawal penalty)
There are also some possible disadvantages with Traditional IRAs though:
- You must begin taking Required Minimum Distributions (RMDs) by Apr. 1st of the current year once you pass the age of 70 ½ (you are NOT required to take RMDs from a Roth IRA)
- If you do NOT withdraw your RMD amount out , you face very stiff penalties from the IRS (at least 50% of your RMD for starters)
- If you are already covered by a retirement plan at work and depending on your tax filing status and income your contributions may not be tax-deductible, or only partially deductible
- There are certain types of investments you cannot make in a Traditional IRA, such as life insurance contracts, antiques, collectibles, and most precious metal coins (there are a few types of coins that are exceptions to this rule)
- You need to have a crystal ball to determine whether tax rates will be higher, lower, or the same as in the future when you retire, which will determine the true effectiveness of Roth IRA compounding investments vs. compounding investments over time (read this last point as “it isn’t easy to figure this out”)
Find an experienced financial advisor who deals with Traditional IRAs on a regular basis, works for an RIA firm, earns his/her money from fees (NOT commissions), believes in having an abundance of investment choices for clients, and has the heart & demeanor of a teacher, NOT a salesperson, and chances are you’ve found the right financial advisor to help you prepare and plan for retirement.