What a Traditional IRA Is

A traditional IRA is a retirement savings account where you can deposit money before taxes are taken out, which lowers your taxable income for that year. The money grows tax-free inside the account. When you withdraw it in retirement, you pay income tax on the full amount you take out — both what you put in and all the growth.

The account is held at a bank, brokerage, or investment firm. You control what happens to the money inside it: you can invest it in stocks, bonds, mutual funds, or keep it in cash. The IRS sets rules about how much you can put in each year, when you must start taking money out, and what happens if you withdraw before retirement age.

Key Takeaways

  • Money you deposit into a traditional IRA may reduce your taxable income in the year you deposit it, depending on your income and whether you have a workplace retirement plan.
  • You pay income tax on withdrawals in retirement, not when you deposit the money, which means you are deferring taxes to a later year.
  • Withdrawals before age 59½ usually trigger a 10% penalty on top of income tax, with limited exceptions for hardship, disability, or first-time home purchase.
  • You must begin taking withdrawals at age 73 (as of 2023), and the IRS calculates the minimum amount based on your age and account balance.
  • Annual contribution limits vary by year and depend on your age and income; the IRS publishes the current limit each January.

How the Tax Deduction Works

When you deposit money into a traditional IRA, you may be able to deduct that amount from your taxable income on your federal tax return. If you earn $60,000 and deposit $7,000 into a traditional IRA, your taxable income drops to $53,000 — assuming you meet the rules for taking the deduction.

The deduction is not automatic. If you have a workplace retirement plan (like a 401(k) or 403(b)), your ability to deduct a traditional IRA contribution phases out once your income reaches a certain level. That threshold varies by year and filing status. If you have no workplace plan, you can usually deduct the full amount regardless of income. Check the IRS website or a tax professional to confirm whether your situation allows a full deduction, partial deduction, or no deduction.

The deduction happens only in the year you make the deposit. If you deposit money in January 2024, you claim the deduction on your 2024 tax return filed in 2025. You do not get a deduction for money that sits in the account in later years.

What Happens When You Withdraw Money

Every dollar you withdraw from a traditional IRA is taxed as ordinary income in the year you withdraw it. If you withdraw $10,000, that $10,000 is added to your other income for the year, and you pay federal income tax on it at your regular tax rate. You may also owe state income tax, depending on where you live.

This is the core trade-off: you saved taxes when you deposited the money, but you pay taxes when you take it out. The IRS assumes your tax rate will be lower in retirement than during your working years, so you come out ahead. That assumption does not always hold, especially if you have large withdrawals or other retirement income.

Withdrawals are not withheld automatically. The financial institution holding your IRA will ask how much federal tax you want them to hold from each withdrawal. If you do not request withholding, you owe the full tax bill when you file your return. Many people underestimate this and face a surprise tax bill.

Early Withdrawal Penalties and Exceptions

If you withdraw money before age 59½, you owe a 10% penalty on the amount withdrawn, in addition to income tax. A $20,000 withdrawal at age 45 costs you $2,000 in penalty plus whatever income tax applies to the $20,000.

The IRS allows penalty-free withdrawals in specific situations: disability, medical expenses that exceed 7.5% of your adjusted gross income, health insurance premiums while unemployed, first-time home purchase (up to $10,000 lifetime), and substantially equal periodic payments (a complex calculation that locks you into regular withdrawals for at least five years or until age 59½, whichever is later). Withdrawals for education expenses, birth or adoption, and domestic abuse are also penalty-free under certain conditions. You still owe income tax on these withdrawals — the penalty is waived, not the tax.

If you do not meet one of these exceptions, the 10% penalty applies. There is no hardship waiver for general financial need. The penalty is calculated by the IRS when you file your tax return; the financial institution does not know whether you may have access to for an exception.

Required Minimum Withdrawals at Age 73

Starting at age 73, you must withdraw a minimum amount from your traditional IRA each year, whether you need the money or not. The IRS calls this a required minimum distribution (RMD). The amount is calculated by dividing your account balance on December 31 of the prior year by a life expectancy factor published by the IRS.

If you do not take the full RMD, you owe a penalty of 10% of the shortfall (as of 2023; this penalty has changed in recent years, so confirm the current rate). The financial institution does not automatically calculate or withdraw your RMD — you must request it or set it up in advance. Many people miss this deadline because they do not realize it applies to them.

If you are still working and do not own more than 5% of the business, you may be able to delay RMDs from a workplace plan, but not from an IRA. Roth IRAs have different RMD rules and may not require withdrawals during the account owner's lifetime.

Contribution Limits and Who Can Open One

The IRS sets an annual limit on how much you can deposit into a traditional IRA. The limit changes each year and is higher if you are age 50 or older (the "catch-up" contribution). For 2024, the limit is $7,000 for people under 50 and $8,000 for people 50 and older; these amounts are adjusted annually for inflation.

You can open a traditional IRA if you have earned income (wages, self-employment income, or taxable alimony). You cannot contribute more than you earned that year. If you earned $4,000, you can deposit at most $4,000, even if the annual limit is higher.

You can have multiple IRAs at different institutions, but your total contributions across all of them cannot exceed the annual limit. If you have a traditional IRA and a Roth IRA, your deposits to both combined cannot exceed the limit.

Traditional IRA vs. Other Retirement Accounts

A traditional IRA is not the only way to save for retirement. If your employer offers a 401(k), 403(b), or similar plan, you can contribute to that instead of or in addition to an IRA. Workplace plans often have higher contribution limits and may include employer matching. A Roth IRA works differently: you pay tax on deposits but withdrawals in retirement are tax-free, and there are no required minimum withdrawals during your lifetime.

The choice between a traditional IRA and a Roth IRA depends on whether you expect your tax rate to be higher or lower in retirement. If you think you will be in a lower tax bracket later, a traditional IRA saves you more money now. If you think you will be in a higher bracket or want tax-free withdrawals, a Roth may make more sense. A tax professional can model both scenarios for your situation.

Self-employed people have additional options: a SEP IRA allows much higher contributions, and a Solo 401(k) combines employee and employer contributions. These accounts have different rules and limits.

Frequently Asked Questions

Can I withdraw money from my traditional IRA without a penalty?

You can withdraw without the 10% penalty if you are age 59½ or older, or if you meet one of the IRS exceptions: disability, medical expenses over 7.5% of your income, health insurance while unemployed, first-time home purchase (up to $10,000 lifetime), or substantially equal periodic payments. You still owe income tax on the withdrawal. If none of these apply, the 10% penalty is added to your tax bill.

What if I do not take my required minimum distribution?

The IRS charges a 10% penalty on the amount you should have withdrawn but did not. If your RMD was $5,000 and you withdrew nothing, you owe $500 in penalty plus income tax on the $5,000. You can request a waiver if you have a reasonable cause, but the IRS rarely grants them. File Form 5329 with your tax return to report the shortfall and request a waiver if you believe you have grounds.

Can I move money from a traditional IRA to a Roth IRA?

Yes, through a process called a conversion. You withdraw money from the traditional IRA and deposit it into a Roth within 60 days. You owe income tax on the converted amount in the year you convert. There is no income limit for conversions, though high-income earners may face additional tax. Consult a tax professional before converting, as the tax bill can be substantial.

What happens to my traditional IRA if I die?

Your beneficiary inherits the account and can withdraw the money, but they owe income tax on withdrawals. The rules for how fast they must withdraw depend on their relationship to you and when you died. A spouse can treat the IRA as their own; other beneficiaries must follow different withdrawal schedules. Name a beneficiary on your IRA account to avoid probate.

Do I have to report my traditional IRA on my tax return?

You report contributions on Form 1040 to claim the tax deduction. You report withdrawals on Form 1040 as well; the financial institution sends you a Form 1099-R showing the amount withdrawn. If you take an early withdrawal with a penalty exception, you file Form 5329 to report it. RMDs are reported on your tax return as income.