What Is the Primary Benefit of a Traditional IRA?

A Traditional Individual Retirement Arrangement, or IRA, is a savings account designed to help individuals prepare for retirement with tax advantages. The primary benefit of a Traditional IRA is the potential for an upfront tax deduction in the year a contribution is made, which can lower your current tax bill. The account also allows your funds to grow without being taxed annually, a concept known as tax-deferred growth.

The Upfront Tax Deduction

When you contribute to a Traditional IRA, you may be able to deduct that amount from your gross income, which is the figure used to calculate your federal income tax. This deduction reduces your taxable income, meaning you pay less in taxes for that year. The value of this deduction is directly tied to your marginal tax bracket, which is the tax rate you pay on your highest dollar of income.

For example, an individual in the 22% federal tax bracket who contributes the maximum of $7,000 for tax year 2024 (for those under age 50) could reduce their taxable income by that amount. The direct tax savings would be 22% of $7,000, which equals a $1,540 reduction in their federal income tax bill for the year.

The ability to realize a tax benefit in the same year as the contribution is a significant draw. This can be particularly advantageous for those in their peak earning years who are in a higher tax bracket, as it makes saving for the future more financially efficient.

Eligibility for the Tax Deduction

Eligibility to deduct Traditional IRA contributions depends on two factors defined by the Internal Revenue Service (IRS): whether you or your spouse are covered by a retirement plan at work, and your modified adjusted gross income (MAGI). MAGI is the specific income figure the IRS uses to determine eligibility for this deduction.

If you are not covered by a workplace retirement plan, you can deduct your full contribution regardless of your income. If you are covered by a workplace plan, your ability to take the deduction is subject to income limitations. For tax year 2024, a single individual covered by a workplace plan can take a full or partial deduction if their MAGI is between $77,000 and $87,000, with no deduction allowed above this range.

For those married and filing jointly in 2024, the income ranges vary. If the contributing spouse is covered by a workplace plan, the deduction phases out with a MAGI between $123,000 and $143,000. If the contributor is not covered by a workplace plan but their spouse is, the phase-out range is between $230,000 and $240,000. These income thresholds are indexed for inflation and can change annually.

Claiming the Deduction and Making Contributions

You have until the federal tax filing deadline, typically April 15th of the following year, to make contributions for the previous tax year. This extended timeframe provides flexibility to fund your retirement account after the calendar year has ended.

To claim the deduction, you must report your contribution on Schedule 1 of Form 1040, “Additional Income and Adjustments to Income.” The amount entered on this form reduces your total income, which lowers your adjusted gross income on your final tax return.

You should keep records of all contributions, especially any non-deductible contributions made because you exceeded the income limits. These non-deductible amounts establish a “basis” in your IRA. Tracking this basis is important to prevent being taxed twice on that money during withdrawals.

Tax-Deferred Growth and Future Withdrawals

A Traditional IRA allows investments to grow on a tax-deferred basis, meaning any interest, dividends, or capital gains are not taxed annually. This allows the full value of your earnings to be reinvested, which can accelerate the compounding and growth of your retirement savings over the long term.

The tax advantage is a deferral, not a complete avoidance of tax. When you take money out in retirement, these withdrawals are taxed as ordinary income at the rate corresponding to your income level in that year. For withdrawals made after age 59½, the entire amount of deductible contributions and investment earnings is subject to income tax.

If you withdraw funds before age 59½, the amount is generally subject to ordinary income tax and an additional 10% penalty. Some exceptions to this penalty exist for situations like a first-time home purchase or qualified education expenses. This future taxation is the trade-off for receiving the upfront tax deduction.