A traditional IRA is a type of retirement account that you contribute to with pre-tax dollars. This means that when you put money into a traditional IRA account, you do not pay taxes on the money as you make the contribution (*see exception for individuals with high incomes below). The money then grows tax-deferred until you are in retirement and ready to start taking the money out. When you begin taking distributions at retirement, everything is taxed at your retirement tax-bracket rate.
As of 2020, an individual can contribute up to $6000 per year to an IRA account. If you are over the age of 50, that number increases to $7000 per year. While investing in a traditional IRA has significant tax advantages, it is important to be aware of a few rules to avoid costly tax penalties. For a traditional IRA, the minimum age before you can start taking withdrawals is 59 ½. If withdrawals are taken prior to 59 ½, you are subject to your normal income tax plus an additional 10% federal tax penalty. Additionally, when you reach age 72, you are required to start taking a Required Minimum Distribution in the amount specified by the government.
*Exceptions for individuals with high taxable incomes:
While anyone can contribute to a traditional IRA, there are phaseout limits for tax deductible contributions. For an individual filing single/head of household, the deduction is phased out between $65,000 - $75,000. For couples filing jointly, the deduction is phased out between $104,000-$124,000. For example, an individual with an annual modified adjusted gross income of $80,000 would be able contribute the full $6000 ($7000 if over age of 50) to a traditional IRA. However, they would not be allowed to deduct their contribution amount from their taxable income for the year.