What is a Traditional IRA and Who Should Have One?

A traditional IRA (individual retirement account) is an account that
is used to save pre-tax dollars for use in retirement. An IRA can be
opened at a variety of places such as a brokerage, mutual fund company,
or even at your local bank. The money in the account can generally be
invested in stocks, bonds, mutual funds, or CDs, subject to the
availability of products within your account.

The Pre-Tax Advantage

The primary benefit of a traditional IRA is that in most cases, the
contributions are made on a pre-tax basis. This means that when you
deposit money into the IRA, you can deduct that amount from your
taxable income. This results in paying less income tax for the year.
For 2007, the maximum contribution to a traditional IRA is $4,000, and
$5,000 if you are age 50 or older.

In addition to receiving the tax deduction up front, the money in
the account grows tax-deferred. Any interest or capital gains from the
investments are not taxed when the gains are realized. Instead, they
are deferred until money is withdrawn from the IRA, at which point the
money is taxed as ordinary income.

Eligibility Requirements

Anyone with earned income is eligible to open a traditional IRA, but
there are some restrictions as to who can deduct the contributions.
There are income limits that are used to determine how much of the
contributions are deductible, if any at all.

If you are currently covered by a retirement plan at work in 2007,
deductibility for traditional IRA contributions are phased out if your
modified adjusted gross income is:

• More than $83,000 but less than $103,000 if married and filing a joint return
  
  
  
• More than $52,000 but less than $62,000 for a single individual or head of household
  
  
  
• Less than $10,000 for a married individual filing a separate return
  

If you live with your spouse or file a joint return, and your spouse
is covered by a retirement plan at work but you are not, the deduction
is phased out if your modified adjusted gross income is more than
$156,000 but less than $166,000.

Distribution Requirements

One of the potential disadvantages of a traditional IRA is the
forced distribution that must begin at age 70 ½. Even if you don’t need
the money, if you do not take at least the required minimum
distribution (RMD) each year, you are subject to stiff penalties. In
addition, withdrawals made prior to turning age 59 ½ are subject to an
early withdrawal penalty in addition to taxes owed.

Is a Traditional IRA Right for You?

If your employer doesn’t offer a retirement plan, then a traditional
IRA is generally your best option for saving pre-tax money for
retirement. Keep in mind that depending on whether or not you’re
married and if your spouse is covered by a retirement plan at work, you
may be subject to income limitations.

For many people, once they reach retirement, they find themselves in
a lower tax bracket than when they were employed. This means you
receive a greater tax break on the contributions during your working
years, and later in life when you are not working and withdraw this
money, it is taxed at a lower rate. Unfortunately, it is impossible to
predict what will happen to tax rates in the future, which is why it is
important to have multiple sources of retirement savings.