If you contribute to a traditional IRA, you can deduct the amount from your income taxes.† For example, if your taxable income for 2020 is $50,000 and you contribute $3,000 to a traditional IRA, your taxable income for the year will be reduced to $47,000. This can reduce the amount of taxes you’ll be subject to each year you contribute.
If you don’t meet the requirements to deduct your IRA contributions, you have the option to contribute to a traditional IRA and not deduct the amount from your taxable income. This means you won’t pay taxes on your investment earnings while you save for retirement, and when you start taking withdrawals in retirement, a portion of your withdrawal (the amount you contributed) won’t be subject to income tax. (Just keep in mind that this approach requires excellent recordkeeping.)
When you withdraw money in retirement (at age 59½ or older), the entire amount you withdraw—original contributions plus earnings—will be subject to income tax.
For example, say you’re retired and have $50,000 of taxable income from various sources—pensions, part-time employment, etc. If you withdraw $3,000 from your traditional IRA, your taxable income for the year increases by that amount. Instead of paying income tax on $50,000, you’ll pay income tax on $53,000.
If you make a withdrawal from a traditional IRA before you reach age 59½, you’ll be subject to a 10% federal penalty tax on the total amount you withdraw.††
Once you reach a certain age, you’ll have to take a required minimum distribution (RMD) from your traditional IRA each year. Originally, this age was 70½. However, due to the Setting Every Community Up for Retirement Enhancement (SECURE) Act, if you reach the age of 70½ after December 31, 2019, you’ll be required to take RMDs starting in the year you turn 72. Your RMD amount is based on your retirement account balance on December 31 of the previous year.