Make the most of your traditional IRA

Generally, investors have two options for their individual retirement accounts (IRAs). The first option is a traditional IRA, and the second option is a Roth IRA (named for the account's congressional sponsor), which features — among other benefits — the ability to receive federally tax-free earnings under certain circumstances. In this article, we'll discuss the features of the traditional IRA. You may want to review material outlining the Roth IRA — or talk to a financial professional — before you make a decision as to which IRA may be suitable for you.

What is a traditional IRA?

A traditional IRA allows any investment earnings to grow tax deferred until withdrawn, typically at retirement. Generally, if you have earned income, you can establish as many IRAs as you want. You may also have an IRA even if you participate in a qualified pension, profit sharing, or other retirement plan. Your entire contribution may not be deductible on your federal income tax return, depending on your income and whether you (or your spouse) participate in an employer-sponsored retirement plan. State income tax laws vary; consult a tax professional to determine how your state treats IRA contributions.
Traditional IRAs offer two distinct potential advantages in terms of taxes: potential deductibility of contributions and tax deferral on any investment earnings.

Rules on contribution limits

In 2024, the maximum annual contribution an individual can make to all of his or her IRAs is $7,000 (in general, married couples filing jointly can contribute a total of $14,000, even if only one spouse has income). Thereafter, the contribution limit will be adjusted for inflation. Individuals aged 50 and older are able to take advantage of "catch-up" contributions to IRAs. The allowable catch-up contribution is $1,000 per year. Starting in 2024, this catch up limit will be indexed for inflation. Maximum contributions may not exceed earned income.
In addition, you can open an IRA or make contributions to an existing IRA as late as the deadline for filing a federal income tax return for that year (without extensions). That means you would generally have until April 15, 2025 to make your 2024 IRA contributions.

Tax treatment of IRAs

Contributions to a traditional IRA may or may not be deductible from your earned income in a given tax year depending on your situation. Income limits apply if either you or your spouse participates in an employer-sponsored retirement savings plan. Deductibility is phased out over certain ranges of income as follows:

Traditional IRA deductibility phaseout ranges for 2024* ($ in Thousands)
Single Filers Joint Filers
Those who are active participants in an employer-sponsored retirement plan $77 - $87 $123 - $143
Those who are not active participants in an employer-sponsored retirement plan, but filing a joint return with a spouse who is actively participating in such a plan N/A $230 - $240
* Based on modified adjusted gross income (MAGI).
If you are married, but you and your spouse file separate income tax returns, you may take a partial deduction for contributions to a traditional IRA if your MAGI is less than $10,000. If your MAGI is $10,000 or more, no deduction is available.

Potential tax-deferred compounding

The ability to make tax-deductible contributions to a traditional IRA can help your current tax situation. But you may want to invest in an IRA whether or not your contributions are deductible. Why? A significant advantage of investing in an IRA is potential tax-deferred compounding of any investment earnings over the long term.
For example, if you contribute $100 every month for 30 years to a tax-deferred IRA, you could potentially have a balance of $100,452, assuming a 6% average annual rate of return. If you made non-deductible contributions, the $36,000 non-deductible contributions would be tax-free and only the earnings ($64,452) would be subject to income tax at the time of distribution.Footnote 1

Change jobs but keep your retirement moneyFootnote 2

IRAs can also come in handy if you participate in an employer-sponsored retirement plan such as a 401(k) plan and leave that job. You can typically take a distribution from the 401(k) plan on termination of employment, and roll over your 401(k) money directly into an IRA or your new employer's plan, if offered, and avoid owing current income tax on the distribution. Starting after 2023, if you terminate employment and your 401(k) account balance is less than $7,000, your employer may automatically distribute your account balance to a default IRA. If your 401(k) distribution is rolled into a default IRA upon your termination of employment, the amount rolled into the default IRA may be automatically transferred to your new employer’s retirement plan. You may contact your employer for more details.
You have choices about what to do with your employer-sponsored retirement plan accounts. Depending on your financial circumstances, needs and goals, you may choose to roll over to an IRA or convert to a Roth IRA, roll over an employer-sponsored plan from your old job to your new employer, take a distribution, or leave the account where it is. Each choice may offer different investment options and services, fees and expenses, withdrawal options, required minimum distributions, tax treatment (particularly with reference to employer stock), and different types of protection from creditors and legal judgments. These are complex choices and should be considered with care. For more information visit our rollover page or call Merrill at 888.637.3343. If you terminate employment and your 401(k) account balance is less than $7,000, your employer may automatically distribute your account balance to a default IRA.
You could also choose to receive part or all of your money as a cash distribution. But any amounts withdrawn will be subject to taxes and may also be subject to a 10% early withdrawal additional federal income tax if you are under age 59½, unless an exception applies.

Withdrawing from your IRA

Generally, any distribution you receive from an IRA before you attain age 59½ is subject to a 10% early withdrawal tax required under the Internal Revenue Code in addition to federal and state income tax. Beginning at age 59½, you can withdraw money (of which any deductible contributions and investment earnings are taxable at your then-current income tax rate) from your IRA as desired without the 10% additional tax, whether or not you are still employed.
But, as with any rule, there are exceptions. Distributions before age 59½ are not subject to the additional tax under certain circumstances, some examples are when:
  • You become permanently disabled;
  • You die before age 59½ and distributions are made to your beneficiary or estate after your death;
  • You make withdrawals to pay deductible medical expenses;
  • You make withdrawals for a qualified first-time home purchase (lifetime limit of $10,000);
  • You make withdrawals to pay qualified higher education expenses for yourself, a spouse, children, or grandchildren;
  • You are a victim of domestic abuse (limit of $10,000, adjusted for inflation);
  • You have an emergency (limit of $1,000).
By April 1 following the year in which you reach age 73, you must begin withdrawals from your IRA (this age will increase to 75 for individuals who turn 74 in or after 2033). A potential advantage of taking only the required minimum distribution amount is that the balance may continue to compound tax-deferred. However, if your distributions in any year after you reach age 73 are less than the required minimum; you may be subject to an additional tax of up to 25% of the amount that should have been withdrawn but was not. If you take the correct distribution in the two-year period following the year when you should have begun taking distributions, the additional tax may be further reduced to 10%.

Consult your Financial Professional

An IRA can become an important part of your personal retirement savings program, providing a foundation for your financial security. That's why it is so important to start planning today. Consult with your financial professional to help you determine how an IRA could help make your financial future more secure. Your financial professional can also work with you and your legal and/or tax advisors before you make any financial decisions.

Footnote 1 This is a hypothetical example used for illustrative purposes only. It is not representative of any particular investment vehicle. It assumes a monthly contribution of $100 and a 6% average annual total return compounded monthly. Your investment results will be different. Tax-deferred amounts accumulated in a traditional IRA are taxable on withdrawal.

Footnote 
You have choices about what to do with your employer-sponsored retirement plan accounts. Depending on your financial circumstances, needs and goals, you may choose to roll over to an IRA or convert to a Roth IRA, roll over an employer-sponsored plan from your old job to your new employer, take a distribution, or leave the account where it is. Each choice may offer different investment options and services, fees and expenses, withdrawal options, required minimum distributions, tax treatment (particularly with reference to employer stock), and different types of protection from creditors and legal judgments. These are complex choices and should be considered with care. For more information visit our rollover page or call Merrill at 888.637.3343.
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The material was authored by a third party, DST Retirement Solutions, LLC, an SS&C company ("SS&C"), not affiliated with Merrill or any of its affiliates and is for information and educational purposes only. The opinions and views expressed do not necessarily reflect the opinions and views of Merrill or any of its affiliates. Any assumptions, opinions and estimates are as of the date of this material and are subject to change without notice. Past performance does not guarantee future results. The information contained in this material does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation, offer or solicitation for the purchase or sale of any security, financial instrument, or strategy. Before acting on any recommendation in this material, you should consider whether it is in your best interest based on your particular circumstances and, if necessary, seek professional advice.

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