A Traditional IRA is one of the most popular retirement savings vehicles in America. It offers tax-deductible contributions and tax-deferred growth, making it an excellent choice for many investors. In this guide, we will explain how Traditional IRAs work and how to use them effectively.
What is a Traditional IRA?
A Traditional Individual Retirement Account (IRA) is a tax-advantaged account designed to help you save for retirement. The key feature is that your contributions may be tax-deductible, which reduces your taxable income for the year. Your investments then grow tax-deferred until you withdraw them in retirement.
The tax-deferred advantage: If you earn $80,000 and contribute $7,000 to a Traditional IRA, your taxable income drops to $73,000. In the 22% tax bracket, this saves you $1,540 in taxes immediately. That savings can be invested and compound over decades.
Traditional IRA Contribution Limits for 2025
The IRS sets annual contribution limits:
- Under age 50: $7,000 per year
- Age 50 and older: $8,000 per year (includes $1,000 catch-up contribution)
You must have earned income (wages, self-employment income, etc.) at least equal to your contribution amount. The contribution deadline is typically April 15 of the following year.
Tax Deduction Rules
Whether your Traditional IRA contributions are tax-deductible depends on your income and whether you or your spouse have access to a workplace retirement plan.
If You Are NOT Covered by a Workplace Plan
Your contributions are fully deductible regardless of income.
If You ARE Covered by a Workplace Plan
For 2025, the deduction phases out at certain income levels:
2025 Traditional IRA Deduction Limits (If Covered by Workplace Plan)
Single filers:
- Full deduction: MAGI under $77,000
- Partial deduction: MAGI $77,000 - $87,000
- No deduction: MAGI over $87,000
Married filing jointly:
- Full deduction: MAGI under $123,000
- Partial deduction: MAGI $123,000 - $143,000
- No deduction: MAGI over $143,000
Even if you cannot deduct your contributions, you can still make non-deductible contributions to a Traditional IRA. The growth remains tax-deferred.
How Traditional IRA Withdrawals Work
Understanding withdrawal rules is crucial for planning:
Qualified Withdrawals
After age 59.5, you can withdraw from your Traditional IRA without penalty. However, all withdrawals are taxed as ordinary income. This includes both your original contributions (if they were tax-deductible) and all investment gains.
Early Withdrawals
If you withdraw before age 59.5, you typically face:
- Ordinary income tax on the entire withdrawal
- 10% early withdrawal penalty
Penalty Exceptions
You may avoid the 10% penalty for:
- First-time home purchase (up to $10,000)
- Qualified higher education expenses
- Unreimbursed medical expenses exceeding 7.5% of AGI
- Health insurance premiums while unemployed
- Disability
- Substantially equal periodic payments (SEPP/72t)
Required Minimum Distributions (RMDs)
Unlike Roth IRAs, Traditional IRAs require you to start taking withdrawals at a certain age:
- If you turned 72 before 2023: RMDs start at 72
- If you turn 72 after 2022: RMDs start at 73
- Starting in 2033: RMDs start at 75
The RMD amount is calculated based on your account balance and life expectancy. Failing to take RMDs results in a 25% penalty on the amount not withdrawn (reduced from the previous 50% penalty).
RMD planning tip: If you expect to have a large Traditional IRA balance, consider converting some to a Roth IRA in lower-income years before RMDs begin. This can reduce your future required distributions and tax burden.
Investment Options in a Traditional IRA
Traditional IRAs offer flexibility in what you can invest in:
- Stocks: Individual company shares
- Bonds: Corporate, municipal, and government bonds
- Mutual funds: Actively managed funds
- ETFs: Exchange-traded funds
- Options: With broker approval
- CDs: Certificates of deposit
- REITs: Real estate investment trusts
You cannot invest in collectibles, life insurance, or S-corporation stock in an IRA.
Traditional IRA Investment Strategies
1. Asset Location Optimization
Traditional IRAs are ideal for investments that generate ordinary income, such as:
- Bond funds (interest taxed as ordinary income)
- REITs (dividends taxed as ordinary income)
- High-dividend stocks
Growth stocks and qualified dividend stocks may be better in taxable accounts or Roth IRAs where they receive more favorable tax treatment.
2. Consider Your Time Horizon
If you are decades from retirement, allocate more to growth-oriented investments. As you approach retirement, gradually shift toward more conservative investments.
3. Take Advantage of Tax-Free Rebalancing
Since there are no taxes on transactions within an IRA, you can rebalance your portfolio without triggering capital gains taxes.
4. Use Options Strategies
Income-generating options strategies like covered calls work well in Traditional IRAs. The premium income is tax-deferred until withdrawal.
Traditional IRA vs Roth IRA
The choice between Traditional and Roth comes down to your tax situation:
Choose Traditional IRA if:
- You need the tax deduction now
- You expect to be in a lower tax bracket in retirement
- Your income is too high for Roth contributions
- You want to reduce current taxable income
Choose Roth IRA if:
- You expect to be in a higher tax bracket later
- You want tax-free withdrawals in retirement
- You do not want required minimum distributions
- You are young and have many years for tax-free growth
Common Traditional IRA Mistakes
- Not contributing the maximum: Lost years of tax-deferred compounding
- Early withdrawals: The 10% penalty plus taxes can cost you significantly
- Forgetting about RMDs: The penalty for missing RMDs is substantial
- Not updating beneficiaries: Outdated beneficiaries can cause estate complications
- Being too conservative: Low-risk investments may not outpace inflation over time
Track Your Traditional IRA Performance
Pro Trader Dashboard automatically tracks your IRA investments, helping you monitor growth and make informed decisions about your retirement portfolio.
Summary
A Traditional IRA offers valuable tax benefits that can accelerate your retirement savings. Tax-deductible contributions provide immediate tax relief, while tax-deferred growth allows your investments to compound without annual taxation. Understand the withdrawal rules, plan for required minimum distributions, and choose investments that make sense for your tax situation to maximize this powerful retirement tool.
Learn more about retirement accounts in our Roth IRA guide or explore required minimum distribution rules.