Traditional IRA

"IRA" redirects here. See also Roth IRA

Introduction
An individual retirement arrangement, or IRA, is a personal savings plan which allows you to set aside money for retirement, while offering you tax advantages. You may be able to deduct some or all of your contributions to your IRA. Amounts in your IRA, including earnings, generally are not taxed until distributed to you. IRA's cannot be owned jointly. However, any amounts remaining in your IRA upon your death can be paid to your beneficiary or beneficiaries.[ See Inheriting an IRA.]

The Traditional IRA was created in 1974 with the passage of the Employee Retirement Income Security Act (ERISA) (see Legislative History of IRAs for a history of the Traditional IRA.) Over the years, the Traditional IRA has been expanded to include a growing number of specialized plan types. These include:
 * Non-deductible Traditional IRAs
 * Roth IRAs
 * SEP (Simplified Employee Pension) IRAs
 * SIMPLE IRAs
 * Coverdell Education Savings Accounts (ESAs)

There are two basic types of personal IRA's: Traditional and Roth.

Traditional IRA
 * Contributions are tax-deductible (depending on income level)
 * Penalty-free withdrawals can begin at age 59 1/2 and are mandatory by 70 1/2
 * Taxes are paid on earnings when withdrawn from the IRA
 * Available to everyone (although tax-deductibility depends on income level)
 * Withdrawals before age 59 1/2 are subject to a 10% penalty (subject to exceptions)

Roth IRA
 * Contributions are not tax-deductible
 * There is no mandatory distribution age
 * All earnings and principal are tax free
 * Available only to those making under a certain income
 * Principal contributions (but not earnings) can be withdrawn at any time without penalty (subject to some minimal conditions)

ICI reports that at year end 2007 Traditional IRA's held an estimated $4.208 trillion of investors wealth accounting for 89% of total IRA assets, and that 32.5% of American households were holding Traditional IRAs. Approximately one half of Traditional IRA assets are rollovers of assets from employer provided contributory plans. [Source:ICI The US Retirement Market, 2007]

Contribution Eligibility and Limits
An individual can contribute to a Traditional IRA up to the year one reaches 70 1/2. The individual must have earned income (wage or business) in order to contribute to a Traditional IRA. Married taxpayers filing joint returns can contribute to a Spousal IRA for the non-working spouse, assuming sufficient earned income. Contributions can be made into an IRA up to the due date of an individual's tax return. For example, most taxpayer's can make 2008 IRA contributions up through April 15, 2009. Taxpayers age 50 and above are entitled to make additional "catch-up" contributions to their IRAs. Contributions are limited to the following annual amounts:

After 2008, the annual contribution limits will be indexed to inflation in $500 increments.

If you or your spouse are covered by an employer provided plan through your employer, your deductible IRA contribution may be limited according to the amount of one's modified adjusted gross income, defined as:

Modified AGI. Your modified AGI for Traditional IRA purposes is your adjusted gross income (AGI) as shown on your tax return modified as follows.

1.Subtract the following:
 * Conversion income. This is any income resulting from the conversion of an IRA (other than a Roth IRA) to a Roth IRA.
 * Minimum required distributions from IRAs, (for conversions only).

2. Add the following deductions and exclusions:
 * Traditional IRA deduction,
 * Student loan interest deduction,
 * Tuition and fees deduction,
 * Domestic production activities deduction,
 * Foreign earned income exclusion,
 * Foreign housing exclusion or deduction,
 * Exclusion of qualified bond interest shown on Form 8815, and
 * Exclusion of employer-provided adoption benefits shown on Form 8839.

The following tables show deductible income limits for individuals covered by an employer plan:

If one's income results in partial deductibility of contributions, one needs to refer to the appropriate tax table to determine the allowable deductible contribution:

Rollovers and Transfers
A significant amount of Traditional IRA assets and annual contributions come from the transfer or rollover of employer retirement plan assets. These transfer/rollovers occur when an employee severs employment from the employer whether voluntarily through job switching or retiring, or through lay-offs or firings. Employees may wish to transfer an employer plan to a Traditional IRA in order to consolidate accounts, reduce plan management expense, or to retain the right to transfer the transferred assets to another employer provided plan. Transfers of Traditional IRA accounts occur in three manners:


 *  Direct Trustee-to-Trustee Transfers
 * Rollovers
 * Transfers incident to a divorce

IRA rollovers and transfers can become complicated. Refer to IRA Rollovers and Transfers for detailed consideration of this topic.

IRA contributions and transfers from 2000-2002 are tabulated below:

[Source: Copeland, Craig, "IRA Assets, Contributions, and Market Share". EBRI Notes, Vol. 28, No. 1, January 2007 Available at SSRN: http://ssrn.com/abstract=959015]

Required Minimum Distributions
With a traditional IRA, once you reach age 70½, you must withdraw at least a minimum amount each year. This is called your required minimum distribution (RMD). Generally, you must take your first RMD by April 1 of the calendar year following the year you turn 70½. (Participants in employer plans who are still working at age 70½ can wait until April 1 of the calendar year following the year they retire.) For each subsequent year, you'll need to take your annual RMD by December 31.

The amount of your required minimum distribution is equal to your retirement account balance as of December 31 of the previous year (adjusted for any outstanding rollovers, asset transfers, or conversions completed during the prior year that are recharacterized in the current one) divided by your life expectancy factor according to the IRS Uniform Lifetime Table.

See Required Minimum Distribution for details.

Penalties: Early Withdrawals and Excess Contributions
Early Withdrawals

Early withdrawals are generally amounts distributed from your traditional IRA account before you are age 59 1/2. You must pay a 10% additional tax on the distribution of any assets from your traditional IRA before you are age 59 1/2.


 * Exceptions to the penalty apply if the early withdrawal is:
 * made to a beneficiary or estate on account of the IRA owner's death,
 * made on account of disability,
 * made as part of a series of substantially equal periodic payments over your life or life expectancy,
 * made to pay for a qualified first–time home purchase,
 * not in excess of your qualified higher education expenses,
 * not in excess of certain medical insurance premiums paid while unemployed,
 * not in excess of your unreimbursed medical expenses that are more than a certain percentage of your adjusted gross income, or
 * due to an IRS levy.

Excess Contributions

Contributing more than the allowed amount in any year to your traditional IRA also subjects you to an additional tax. Any excess contribution not withdrawn by the date your tax return for the year is due (including extensions) is subject to a 6% tax. You must pay the 6% tax each year on excess amounts that remain in your traditional IRA at the end of your tax year.

Links
Legislative History of IRAs

IRS

 * IRS Publication 590 Individual Retirement Arrangements (IRAs)

Papers

 * Holden,Sarah, Ireland,Kathy, Leonard-Chambers,Vicki and Bogdan, Michael, "The Individual Retirement Account at Age 30: A Retrospective" Investment Company Institute Vol.11 No.1 (February, 2005). Available at http://www.ici.org/pdf/per11-01.pdf
 * Reichenstein, William, "Tax-Efficient Sequencing Of Accounts to Tap in Retirement" TIAA-CREF Institute (October, 2006). Available at http://www.tiaa-crefinstitute.org/research/trends/docs/tr100106.pdf