What is a Traditional IRA? The Pros & Cons Explained.
Anyone who is attempting to save for retirement owes it to themselves to learn how to take advantage of tax deferment. While many tax deferred investments options are worth considering, none are perhaps quite as well known as the traditional / deductible individual retirement account (IRA). First created in 1974 as a result of the Employee Retirement Security Act, the traditional IRA is now a fixture of many people’s retirement plans, and for good reason. All this said, traditional IRA accounts aren’t for everyone, as they do come along with certain drawbacks that are important to pay attention to. All retirement accounts come along with limitations of some sort, and IRAs are no different. Once you understand the pros and cons, however, you’ll have a much better idea as to whether or not this type of account is right for you and your retirement.
The Pros of a Traditional IRAFans of the traditional IRA can find a lot to love about this type of account, including the following undeniable benefits:
Growth, Tax-FreeIf there’s one reason why people of all walks of life have settled on the traditional IRA as their main retirement savings vehicle, it’s tax-free growth. This is a feature of both traditional and Roth IRAs, essentially meaning that there should be no concern about tax levies of any kind occurring on the capital gains of the investment. With a 401(k), for example, taxes must be paid whenever a withdrawal is made on the amount removed from the account. This is not the case with a traditional IRA.
Flexible Contribution RestrictionsWhile plenty of people would like to have the opportunity to contribute to a matched 401(k), not everyone is lucky enough to work for an employer that offers such a retirement package. A traditional IRA will be well-suited to this type of candidate, especially given how many people are eligible to open this type of account. Anyone who has earned income is allowed to contribute to an IRA. Note, however, that in a scenario where one has earned, say, only $3,000 in a year, he or she can only contribute a maximum of $3,000 to an IRA for that year. Still, a traditional IRA is a great account for getting children started on the path toward a successful retirement given how flexible contribution restrictions tend to be.
Extended Contribution TimelineOne benefit of the IRA that often goes overlooked is the extended contribution timeline associated with this type of account. With a traditional IRA, you’ll have until the 15th of April to make your yearly contribution, which means you actually have 15.5 months as opposed to 12 months to fill the account. This extra leeway may not make a huge difference for everyone, but for some, it will play a key role in maximizing the benefits of the individual retirement account.
The Cons of a Traditional IRAJust as with every other type of retirement account, the traditional IRA is certainly not perfect. There are a handful of reasons why one might wish to stay away from opening a traditional IRA, including the following:
Required Minimum Distributions (RMDs)One of the unfortunate truths about storing money in a traditional IRA is that you will eventually need to make required minimum distributions (RMDs). Currently, RMDs must be performed by April 1st once a person reaches the age of 70.5. Note that one RMDs do not factor into the Roth IRA, which is one of the main reasons why many people choose that variation on this type of retirement account over the traditional IRA.
Interference of Employer PlanIf you do have access to an employer-sponsored retirement plan, you may have chosen to opt-in at one point or another. Depending upon your tax filing status, it’s possible in this scenario that not all of your IRA contributions will be tax-deductible, which defeats the purpose of setting this type of plan up in the first place.
Investment RestrictionsFinally, traditional IRAs don’t allow for certain types of investments to be made, which some may find frustrating. Take, for example, life insurance contracts, which — along with antiques, collectibles, and some precious metal coins — cannot be incorporated into an IRA as investments. There's an emphasis on some, as there are many IRS eligible metals that can be purchased for an IRA, including the iconic American Eagle coin. You can learn more about what is eligible and how gold IRAs can help you secure your financial future by reading this article.
The Bottom LineAt the end of the day, whether or not a traditional IRA is a good fit will depend largely on your own unique circumstances. Some will find more value in a Roth IRA, while others may choose to steer clear of the individual retirement account altogether. When the right circumstances lineup, however, a traditional IRA can be a very effective route toward a successful retirement.
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