The benefits of traditional IRAs

Are you looking for a way to save for retirement beyond the retirement plan offered through your employer? If so, you may want to consider a traditional individual retirement account (IRA). These retirement plans not only can supplement your current savings, but they provide tax advantages.

We'll cover:

• What is a traditional IRA?
• Benefits of traditional IRAs
• 2023 & 2024 IRA contribution limits
• How traditional IRA withdrawals work
• When to choose a traditional vs a Roth IRA
• Can you have more than one IRA?

A traditional IRA is a type of qualified retirement savings plan. You make contributions that have the potential to experience compound interest and tax-deferred growth over time. Even if you have access to an employer-sponsored retirement plan, such as a 401(k), you still can contribute to an IRA and put more toward your retirement savings each year.

To qualify for a traditional IRA, you or your spouse must have earned income from wages, salaries or tips from working. Income from real estate rentals, interest, dividends and other types of passive income doesn't count.

There are no age requirements or income thresholds to open a traditional IRA.

Traditional IRAs offer several benefits that make them a popular option to help boost retirement savings. They offer:

• A way to supplement your retirement savings outside of your employer-sponsored programs. According to Thrivent's Retirement Readiness Survey, 42% of those nearing retirement plan to rely on a mix of assets such as a 401(k), personal savings, Social Security benefits and individual retirement accounts (IRAs).¹ Traditional IRAs are also a popular option if you don't have access to a retirement savings plan through your employer.

• Tax-deferred growth potential. Traditional IRAs are tax-deferred, meaning you contribute pretax dollars and defer paying taxes until you withdraw funds. The benefit of tax-deferral is that it gives your money the potential to grow over the long term.

• Your contributions may be tax-deductible. If you (or your spouse) don't have access to an employer-sponsored plan, traditional IRA contributions are tax-deductible. If either of you does have an employer-sponsored retirement plan, your contributions are tax-deductible if your income falls below certain thresholds.²

• Qualified withdrawals that are penalty-free. While the express purpose of a traditional IRA is for retirement savings, life happens, and you may need some of the funds early. You can make penalty-free withdrawals before the age of 59½ for qualifying expenses, such as a birth, an adoption, educational expenses or a first-time home purchase. You can view the full list of exceptions here.

• A choice of a variety of investment options. With a 401(k) or other retirement plan offered through your employer, you may be limited in the available investment choices. However, opening a traditional IRA allows you to choose from stocks, bonds, mutual funds and certificates of deposit (CDs), which can help you diversify your portfolio and meet your risk tolerance.

The IRS sets annual contribution limits for IRA contributions. These limits apply to both traditional and Roth IRAs.¹

• 2023 contribution limit: $6,500
• 2024 contribution limit: $7,000
• If you're over age 50, you may make a catch-up contribution of an additional $1,000

Another way to contribute to your IRA is by rolling over money from another retirement account. Funds rolled over do not count toward the annual contribution limit.

There is also an important date to remember for contribution deadlines:

• The deadline to contribute to an IRA is typically April 15 of the following tax year. (If April 15 falls on a weekend or holiday, the deadline typically shifts to the following business day.)
• The deadline to withdraw excess contributions is by Tax Day (plus extensions) if you've exceeded your IRA contribution limit. Otherwise, you may have to pay a 6% tax on the excess amounts in your account each year.

Traditional IRA distributions have important rules dictating when you can begin withdrawing your funds:

• You can withdraw penalty-free as early as age 59½, with your withdrawals taxed at your current income.

• If you withdraw funds before 59½, you may face a 10% penalty unless you qualify for an exception. Exceptions include to pay health insurance premiums after a job loss, to purchase a first home, to help pay for the birth or adoption of a child, and to help pay qualified education costs for you or a family member. You can view the full list here.

Required minimum distributions, or RMDs, are the minimum amount of money you must withdraw from a tax-deferred retirement plan after you reach a certain age. You can use this distribution in many ways—like living expenses, charitable donations and reinvesting in another way—but you do have to pay income taxes on these withdrawals.

The Secure Act 2.0 updated RMD age requirements using a sliding scale determined by your birthdate:

• If you turn 73 before 2033, you start taking RMDs at 73.
• If you turn 74 after 2032, you start taking RMDs at 75.
  

Your financial advisor can help you plan a traditional IRA distribution strategy as you get closer to retirement or RMD age.

Woman working from home using laptop computer while reading text message on mobile phone

Woman in home office during Covid-19 lockdown

Are your retirement savings on track?

Each decade of your working life serves as a guide to navigating the nuances of creating a strong retirement plan. Explore retirement planning in your 30s, 40s, 50s and 60s.

Get the guideposts

When determining if a traditional IRA is right for you, you should weigh its counterpart — the Roth IRA. The purpose of a Roth IRA is the same — a tax-advantaged savings vehicle for the purpose of retirement. However, the difference is in the taxation of the accounts.

Unlike a traditional IRA that is funded with pre-tax dollars, a Roth IRA allows you to make contributions with dollars you've already paid taxes on, so you won't have any additional tax liability when you take withdrawals in retirement. Another difference is that Roth IRAs don't have RMD requirements, but they are subject to income limits and early withdrawal penalties.^3,4

Depending on your long-term strategy and interest in income tax diversification, one may hold more advantages over the other.

• You and/or your spouse have earned income.
• You believe you are in your peak income-earning years now and believe that when you retire, you may be in either the same or a lower tax bracket than you are now.
• You may benefit from qualifying for income tax deductions on your contributions.
• You feel confident you won't need to access these funds until 59½, or if you need the money, it will be for qualifying penalty exemptions.

• You and/or your spouse have earned income.
• You meet the income limits for participation.³
• You (or your spouse) plan to earn your peak income closer to retirement and you believe you may be in a higher income tax bracket in retirement than you are now.
• You think you will benefit from tax-free withdrawals in retirement.
• You don't want to worry about RMDs and prefer to let your money grow tax-free after your RMD age.
• You want the option to withdraw funds penalty free before 59½, if your Roth IRA meets the five-year rule and qualifying requirements.

Yes, you can have more than one IRA and add funds to each. However, the total contributions can't exceed the IRS yearly limit. For example, if you're 40 and have both a traditional and Roth IRA in 2024, you can contribute to those IRAs in any combination, such as $3,500 in each or $1,000 in one and $6,000 in the other.

Many financial institutions offer personal IRA accounts, including traditional and online banks as well as brokerage firms. Once you've decided where to open your IRA, you'll be able to fund your account and pick your investments.

You typically can fund your IRA through direct deposit, cash, checks or money orders. Then, you can set up continued deposits through your bank account up to the yearly contribution limit.

If you'd like help learning more about your options and how an IRA may help benefit your retirement dreams, connect with a local Thrivent financial advisor.