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What Is a Traditional IRA?

The traditional individual retirement account (IRA) is a popular retirement plan for many investors. Besides helping to provide your retirement nest egg, the contributions you make may be tax-deductible.

In order to identify the traditional IRA, it may help if we distinguish it from the Roth IRA. The differences lie in deductibility and taxability. For the sake of clarity, remember that every IRA has two components: the contributions you make to it, and the earnings that grow in it.

The traditional IRA has these characteristics:

  • Contributions you make may be tax-deductible.
  • If your contributions are deductible, you will be taxed on them when you make withdrawals (your contributions must be taxed at some point).
  • The dividends and capital gains that build on your contributions will not be taxed until you make withdrawals.
The Roth IRA has these characteristics:

  • Contributions you make are never tax-deductible.
  • You will not be taxed on your contributions when you withdraw them.
  • The dividends and capital gains that build on your contributions will not be taxed at all if you begin making withdrawals after age 59½ and you have waited at least five years to do so.

The largest contribution allowable to either plan for 2008 and 2009 is the smaller of $5,000 or 100 percent of earned income from employment. Unmarried individuals must have earned income in order to contribute to IRAs. In many situations, spouses of income-earners who have little or no earned income of their own may rely on their spouse's earned income to make an IRA contribution. One must not exceed the maximum contribution amount for all traditional and Roth IRA accounts combined. The law also allows taxpayers age 50 and above to make an extra, "catch-up" contribution of $1,000. So, in 2008 and 2009, the over-50 taxpayer is scheduled to have a $6,000 annual IRA contribution limit.

If you are currently in a high tax bracket but foresee being in a lower one after you retire, you can benefit greatly from a traditional IRA, because your withdrawals will be taxed at your then current rate.

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What Is a Traditional IRA?

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