Traditional IRA Definition, Rules, & How It Works

The benefits of a traditional IRA (individual retirement account) outweigh the drawbacks and can help you build a nest egg for retirement.

Take time to prepare for future financial stability by understanding what a traditional IRA is, how it works, and what it can do for you.

What is a Traditional IRA?

The traditional IRA was created by legislation in 1974 to encourage working individuals to set aside a portion of their wages for retirement. 

Traditional IRAs allow individuals to contribute pre-tax dollars to the account where the investments grow tax-deferred until withdrawal.

Tax-deferred is the technical way of saying that you won’t be expected to pay ordinary income tax on the money as long as it’s in the account.

Contributions to a traditional IRA may be tax deductible – and subject to a full or partial tax deduction, depending on the account holder’s filing status and income.

How Does a Traditional IRA Work?

A traditional IRA allows you to save for retirement with contributions that grow tax-deferred. That means you won’t owe taxes on your investments until you withdraw money from the account once you reach retirement age. 

With a traditional IRA, you can invest in various stocks, bonds, and assets without reporting the gains on your taxes each year.  

You may also qualify for a tax deduction for your traditional IRA, depending on your annual income. If you aren’t eligible but continue to contribute, the government won’t tax your contributions upon withdrawal. 

However, investment earnings and interest is taxable.

Distributions & Withdrawals

The IRS does not allow you to keep funds in your retirement account indefinitely. You can start withdrawing money as early as age 59 ½, but are required to take the minimum distribution amount by age 72. 

The required minimum distribution (RMD) is calculated by dividing the account’s past year-end fair market value by the distribution period or life expectancy.

The IRS website has worksheets and additional resources to help determine the RMD.  If you withdraw money from your traditional IRA before age 59 ½, you could incur a 10% penalty tax on the amount withdrawn.

Some situations exclude account holders from paying an early withdrawal penalty, including:

• If you plan on purchasing, building, or rebuilding a first home for you or a qualified family member (up to $10,000).
• Childbirth or adoption (up to $5,000).
• Qualified education expenses.
• Qualified medical expenses, including health insurance, while unemployed.
• You are disabled or become disabled before distribution occurs.
• A beneficiary receives your assets after your death.
• The assets are distributed as a result of the IRS seizing your account.
• The allocated amount is a return on nondeductible contributions.
• You are active-duty military for more than 179 days.

Always check with the IRS or a tax attorney to ensure that your situation meets the waiver’s qualifications.

Traditional IRA Limits 2025

The IRS restricts the amount an individual can add to a traditional IRA each year. The 2025 traditional IRA contribution limit is $7,000 for those under age 50. 

For account holders 50 and above, the contribution limit is $8,000 (standard $7,000 + $1,000 catch-up contribution).

If you are single and covered by a retirement plan at work, you can still contribute to a traditional IRA. This also applies to married couples who participate in employee retirement plans. 

However, if you or your spouse exceeds certain income levels, you may not be able to deduct the entire contribution. If you’re married, you and your spouse can also contribute to separate traditional IRAs.

The total contributions to you and your spouse’s IRAs may not exceed your joint taxable income or the annual contribution limit times two — whichever is less. 

There’s no requirement that you must contribute the full amount each year, but keep in mind that the limit applies to all of your IRAs. If your limit is $7,000 and you contribute $3,000 to a Roth IRA, you’ll only have $3,000 left to put into the traditional IRA.

Traditional IRA vs. Roth & 401k

Let’s break it down even further by comparing the traditional IRA to the Roth IRA and 401k.

Traditional IRA vs. Roth IRA

The difference between a traditional IRA and a Roth IRA comes down to when you pay income taxes.  As you’ve learned, with a traditional IRA, your contributions aren’t taxed until after you withdraw them, so you enjoy tax-free money while saving for retirement. 

A Roth IRA flips the coin by taxing your contributions as you put them in but gives you a tax break in retirement. When it comes time to withdraw, your money will be tax-free, granted your account has been open for at least five years.

A few other key differences:

• Roth IRAs do not have required minimum distributions.
• Roth IRA contributions have income limits.
• You can continue contributing to a Roth IRA after you turn 70 ½ if you have earned income or self-employment wages.

A Roth IRA may benefit you expect to be in a higher tax bracket when you retire, if you’re a recent college graduate, or if you’re early in your career. 

Traditional IRA vs. 401(k)

A traditional IRA and 401(k) are similar in many respects: they’re both tax-deferred, penalty-free withdrawals begin at age 59 ½, and the required minimum distribution begins at age 72.

The most significant difference is that the employer manages and contributes to the employee’s 401k.  Some employers offer 401k matching.

Investopedia says that typically this means that the employer will match a percentage of your contributions, up to a certain amount of your total salary. 

Another difference of the 401(k) is that contributions are pre-taxed, and your investments are limited by a plan. The contribution limit is also much higher, at $19,500.

To maximize retirement savings, many people contribute to both a 401k and a traditional IRA.

How to Open a Traditional IRA Account

In today’s world, opening a traditional IRA can be as easy as opening your laptop. Follow the steps below for guidance on how and where to open an IRA account. 

1. First, decide if a traditional IRA is the right choice for you. After reading this article, you should have a good idea of how a traditional IRA can benefit you, as well as information on Roth IRAs and employee-sponsored retirement accounts.
2. Choose a financial institution that offers traditional IRAs. These include banks and credit unions, mutual fund companies, online brokers, and robo-advisors.
3. Depending on where you’ve chosen to open your account, you’ll either meet with someone in person or go to the provider’s website and fill out some light paperwork.
4. Next, you’ll fund your IRA account. You can do this by transferring funds from your bank account to your IRA account, transferring previous IRA contributions into your new account, or by rolling over an existing 401k.
5. Choose where to invest your money.

Choosing where to invest your money comes down to your needs and goals. If you take the hands-on approach, meaning you want to pick and manage your investments on your own, you can get help from an online broker. 

What’s Next?

There’s no time like the present to prepare for the future, and you’ve taken the first step by reading this article and familiarizing yourself with one of the most common retirement plans — the traditional individual retirement account. 

With a traditional IRA, you’ll also have flexibility both in where you open your IRA and where you invest, and most institutions allow you to open and manage your IRA with few to no costs. 

If you’re self-employed, earn taxable income, or your income level is higher than what’s eligible for a Roth IRA, the traditional IRA is a retirement plan worth considering. 

And of course, you can continue your research by diving into our and recommendations.

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