As the name suggests, Traditional IRA is one of the oldest Individual Retirement Account in United States. IRA accounts are primarily savings account; the benefits of which are reaped in one’s old age. IRA accounts are used to accumulate money with a government sponsored agency or some other reliable private agency. For example you can open a Traditional IRA account with a bank. The bank may allow you to invest your IRA account contributions in instruments like bonds and CDs (Certificate of Deposit). Thus your contribution will start earning interest thereby adding a sizeable amount to your savings. Similarly, if you open a Traditional IRA account with a brokerage firm, then you can invest into securities, equity funds, debt funds, etc.
One of the main advantages of a Traditional IRA is its tax free contributions. This means that as far as the money lies in your Traditional IRA account, it will not attract tax. This includes your contributions to the account. Since you can invest your contributions into fixed and variable return instruments, you are bound to mostly make some income on your investment. Even these additions to the account are not taxable.
However, the catch lies in withdrawal. All withdrawals from a Traditional IRA account are tax liable. Applicable federal tax rates apply when you withdraw money. This is exact opposite to a Roth IRA where contributions are tax liable but not any withdrawals.
Contributions to a Traditional IRA account are limited. For example, if you are 50 or above the age of 50, then for the year 2006 you can maximum add $5,000 to a Traditional IRA account. So say, if the federal tax rate applicable to you is @15% then you will save a tax of $750. However, if you are below the age of 49, then maximum contribution for 2006 is $4,000. At rate of 15%, you will then save only $600.
Another major rider to Traditional type of IRA account is the income limits. On an approximate scale, if your gross income exceeds $80,000, then all your contributions are taxable. That means you loose the biggest advantage of Traditional IRA account. On the other hand, if your gross income is approximately below $40,000, then your entire contributions for the year (provided they are below the maximum contribution allowed) are tax free. The exact gross income threshold limits depends upon how you file your income tax return. Singles have least income threshold and if you file “Married filing jointly” or similar, then income thresholds are higher.
So which IRA account is best for you? The answer lies in your foresight. If you think, that you will retire from professional life and your income will be very less in your old days, then Traditional IRA can be a good pick. But remember that, after age of 70 and a half, you cannot take or continue a Traditional IRA. A thoughtful selection can prove to be a big help at the time when you need it most.