Traditional IRA: A Guide to Retirement Planning

Time flies when you’re having fun, so before you know it, you might be nearing retirement age. That means you get to stop working — amazing! — but only if you’ve saved enough money to afford not having an income. You can build these savings over several decades with a traditional individual retirement account, best known as a traditional IRA. With this type of IRA, your savings grow tax-deferred, meaning you don’t pay taxes on them until you withdraw them in retirement. Here’s our guide to traditional IRAs, which you can open as a CD at UBank.

Advantages of a traditional IRA

There are two main types of individual retirement accounts: a traditional IRA and a Roth IRA. We’ll go in-depth on Roth accounts later, but for now, here are why traditional IRAs might be the better pick for you.

• You pay taxes later, not now. The federal government levies taxes on all retirement account investments at one point or another. With a traditional IRA, you pay these taxes — which are federal income taxes — only when you withdraw money during retirement. This means you can grow your retirement account’s value more quickly since you’re not losing money to taxes as you invest.
• You can open an account no matter your income. Unlike with a Roth IRA, there are no income limitations to open a traditional IRA. This means you can save for retirement whether you’re earning an entry-level salary or you’re well over a decade into your career.
• You can claim tax deductions — well, sometimes. Unlike with a Roth IRA, contributions to a traditional IRA may be tax-deductible. We’ll break this down in the next section since it involves lots of numbers and if-then statements.

How to deduct traditional IRA contributions from your taxes

Whether you can deduct your IRA contributions from your taxes depends on two main factors. First, there’s your tax filing status: Are you a single filer, a head of household, or married? There’s also your modified adjusted gross income (MAGI), which is your gross income (your annual salary) minus certain tax deductions. If you get your traditional IRA through an employer-sponsored retirement plan, you can deduct the below contribution amounts for tax year 2023.

• If you’re a single filer or a head of household:
  You can deduct your entire contribution amount if your modified adjusted gross income (MAGI) is at most $73,000.
  You can deduct part of your total contribution amount if your MAGI is above $73,000 and at most $83,000.
  You can’t deduct any contributions if your MAGI is above $83,000.
  
  
• If you’re married filing jointly or you’re a qualified widower:
  You can deduct your entire contribution amount if your modified adjusted gross income (MAGI) is at most $116,000.
  You can deduct part of your total contribution amount if your MAGI is above $116,000 and at most $136,000.
  You can’t deduct any contributions if your MAGI is above $136,000.
  
  
• If you’re married filing separately:
  You can deduct part of your total contribution amount if your MAGI is less than $10,000.
  You can’t deduct any contributions if your MAGI is above $10,000.

If you get your traditional IRA in any way other than an employer-sponsored retirement plan, you can deduct the below amounts for tax year 2023.

• If you’re a single filer, a head of household, or a qualifying widow, you can deduct your entire contribution amount.
• If you’re married and filing jointly or separately with a spouse lacking an employer-sponsored retirement plan, you can deduct your entire contribution amount.
• If you’re married filing jointly with a spouse whose employer sponsors their retirement plan: You can deduct your entire contribution amount if your modified adjusted gross income (MAGI) is at most $218,000. You can deduct part of your total contribution amount if your MAGI is above $218,000 and at most $228,000. You can’t deduct any contributions if your MAGI is above $228,000.
• If you’re married filing separately with a spouse whose employer sponsors their retirement plan: You can deduct part of your total contribution amount if your MAGI is less than $10,000. You can’t deduct any contributions if your MAGI is above $10,000.

Traditional IRA eligibility and annual contribution limits

You can open and contribute to a traditional IRA at any age. What changes with your age isn’t your ability to contribute — it’s how much you can contribute. Namely, if you’re under 50 years old, you can contribute at most $6,500 to your traditional IRA in tax year 2023. This amount increases to $7,500 if you’re 50 or older. The extra contributions for older investors are known as “catch-up contributions” — the idea being that, with retirement approaching, it’s time to catch up on saving!

Notably, these contribution limits apply across all your traditional IRAs and Roth IRAs, not just per each account. That’s right — it’s totally possible to have more than one retirement account! This can help you diversify the types of assets in which you’re investing your retirement savings, and that’s always a smart move.

Traditional IRA investment strategies: diversification and risk management

The more assets in which you invest, the more you minimize your risk of financial loss. This principle, known as diversification, comes into play big-time in traditional IRAs. With your IRA, you’ll often have the power to choose what percentages of your money goes toward bonds and toward stocks.

You’ll likely fare best if you increase your bond allotment as you approach retirement age and invest more in stocks at younger ages. This is because stocks often return higher yields over time but carry much more risk. A market crash — or even just a bad news day for a company whose stock you’ve invested in — can send prices tumbling. Your retirement account’s value falls in tandem.

Smart choices when it comes to stock versus bond allocation are the root of savvy risk management. Your goal is to balance your risk tolerance with the investment decisions that typically result in the highest profits.For example, maybe you’re trying to grow lots of money in your account within the next few years. This could make investing much more in stocks than bonds a fair choice given your risk tolerance. If you’re instead risk-averse, shifting toward bonds is probably best. Visit your nearest UBank branch for personalized, in-person advice on this!

Traditional IRA required minimum distributions (RMDs)

With a traditional IRA, you must withdraw money yearly from your account to remain compliant with federal tax guidelines. These withdrawals are known as required minimum distributions (RMDs), and the IRS determines their amounts based on life expectancy factors. These factors and the math that determines your RMD amount can be complicated to understand. We suggest skipping the algebra and just using an online RMD calculator.

Notably, RMDs are taxed as ordinary income, meaning you’ll pay federal income taxes on them. The tax deductions you can claim based on your contribution amounts can decrease your MAGI so that you fall into a lower tax bracket. This can be an effective strategy for minimizing the amount of your RMD that you lose to taxes.

What’s not an effective strategy: Not taking your RMDs at all. This can lead to your IRA being disqualified or you owing a penalty equal to 50% of your RMD amount. Neither of these outcomes is worth deciding not to withdraw your required amount just to avoid tax payments.

What is a Roth IRA, and should you convert to one?

With a Roth IRA, you pay taxes on your contributions the very moment you make them. This means you don’t pay taxes when you withdraw money in retirement. However, Roth IRA contributions are never tax-deductible, and you can’t have a Roth IRA if your MAGI exceeds certain income limits. For tax year 2023, the Roth IRA MAGI limit is $153,000 for single filers and $228,000 if married and filing jointly.

Additionally, you can only contribute earned income to a Roth IRA. This means that only the money you earn as an employee — including as a self-employed person — can go into your account. This restriction doesn’t apply to traditional IRAs, so theoretically, that holiday gift money from a friend or family member could go into your account. But not with Roth IRAs.

There are two major advantages of a Roth IRA: Your retirement withdrawals aren’t taxed since you pay taxes upon investing, and there are no RMDs. This taxation structure is great if tax rates increase over time since you pay less on your money. It can also be freeing to lack any firm requirements to withdraw your money in retirement. You might thus be interested in converting your traditional IRA to a Roth IRA, which you can do if you qualify for a Roth IRA.

That said, this conversion requires you to pay income taxes on your traditional IRA funds since you must withdraw them to convert your account. Additionally, since these funds are taxed as income, a large conversion amount could push you into a higher tax bracket for the year. Small conversions, also known as rollovers, over many years may keep you in your current bracket. A UBank advisor can help you figure out the right moves to make — and plot out a timeline for taking action.

Save for retirement with expert help

At UBank, we offer traditional and Roth IRAs that you can open as certificates of deposit (CDs) with an initial investment of just $500. We’re here for your rollovers too — go ahead and bring over your funds from your existing IRA or employer-sponsored retirement plan. Plus, we’ll do more than hold and invest your money. We’ll also demystify all the complexities of saving for retirement and give you advice customized to your exact situation. Visit your nearest UBank branch today for a helping hand from an expert right in your neighborhood.