Pros and Cons of a Traditional IRA – MoneyDope (2024)

What is a Traditional Individual Retirement Account (IRA)?

A Traditional IRA is a type of retirement account that an individual human (you) opens and controls themselves. When you open a Traditional IRA, you begin to set your future up for success while taking advantage of some very specific tax advantages. Traditional IRAs are similar but have some distinct differences from Roth IRAs. Let’s take a look at the pros and cons of a traditional IRA.

The Cons of a Traditional IRA

Distribution Taxes

When you’re finally old enough to start pulling that money that’s been growing for all those years out, you’ll pay taxes on it. That’s right! You spent all your life putting money into the account and deducting it each year on your taxes, but you can’t expect that the government would be so nice to let you take the money back out of the account without a catch. The strategy to this method is the tax-free growth the account makes over the years and if you expect to be in a lower tax bracket during retirement. If you’re in a lower tax bracket when you’re drawing the money out than you would have been when you contributed, you would be using the Traditional IRA strategy properly.

Required Distributions

The government wants their taxes before you croak. If you haven’t already started taking your distributions by the eligibility age (59 ½) then you’ll be forced to once you reach the age of 70 ½, regardless of your plans.

Penalties for Early Withdrawal

So, you want to pull that money back out right now huh? Well, if you’re younger than 59 ½ (at the time of this writing), you can expect to pay some nice penalties for that. In other words, if you’re contributing money to your Traditional IRA, make sure you don’t have it in your plans to use the money before you’re old enough to not pay fees. Things happen and it’ll help you sleep better knowing you have some additional cushion if it’s absolutely needed. But again, do yourself a favor and don’t plan to pull the money out early.

The Pros of a Traditional IRA

Contribution Deductions

Possibly the biggest advantage to a Traditional IRA is the ability to deduct the contributions that you make to the account. At the time of the writing, the annual contribution limit is $6,000. Say you contribute $4,000 to your Traditional IRA this year. Next year, you’ll be able to deduct $4,000 from your taxable income. Basically, you’re telling the government that you made $4,000 less so you pay less in taxes. Keep in mind that if you or your spouse contribute to an employer sponsored retirement account such as a 401k, you may face limitations on how much you can deduct so be sure to consider that as well. This is known as your modified adjustable gross income.

Tax-free Growth

Exposure to companies within the stock market is a massive advantage of an IRA. With exposure to the stock market comes the potential for massive growth over time. As your account grows, you won’t pay taxes. Say you buy a company stock, and it performs very well over the next 10 years. When you go to sell it, the proceed and gains are all yours to keep. Conversely, in an individual brokerage account that doesn’t have tax advantages like an IRA, you’d pay capital gains tax on those gains during the next tax season.