An individual retirement account (traditional IRA) is a tax-deferred investment account that allows account holders to contribute up to $6,000 per year pretax as a way to save for retirement. Account holders can invest to grow their IRA without paying any taxes on contributions or gains until money is withdrawn from the account during retirement.
A traditional IRA is one of the few tax-deferred retirement accounts available under IRS rules that aren’t an employer-sponsored retirement plan, which means that any taxpayer can set up their own individual retirement account, so long as they work with a qualified IRA custodian, follow traditional IRA account rules and meet IRS deadlines.
Opening an IRA is easy and can be done online in minutes. With TD Ameritrade, there’s no minimum deposit required to open and new account holders can qualify for up to $600 bonus.
How a Traditional IRA Works
Using a traditional IRA, you can contribute up to $6,000 pretax each year to your account. Your IRA limits may vary based on income limitations, whether you’re eligible for a retirement plan through work and whether you’re over age 50 because then you can contribute up to $7,000 with catch-up contributions, also pretax.
After you contribute to an IRA, you can invest to grow your account tax-free. IRAs are typically invested in things like stocks, bonds, mutual funds and exchange-traded funds (ETFs) hoping to achieve returns that are several percentage points higher than more conservative CDs or Treasury bonds — 6 percent to 7 percent or higher.
You aren’t taxed on traditional IRA contributions or gains until you withdraw money from your account after age 59 1/2, and then those withdrawals are taxed as income. The advantage of a traditional IRA is that, although withdrawals are taxable as income, your income tax rate during retirement will likely be lower than during working years.
Traditional IRA Investment Options
Typical investment options in a traditional IRA include stocks, bonds, mutual funds and ETFs that are available through most brokerage firms and mutual fund companies. While there are additional traditional IRA investment options allowed under IRA account rules, these are the only options made available through most approved IRS custodians.
Some traditional IRA investment options typically available include:
- Stocks: Shares in individual companies
- Bonds: Debt issued by companies, countries and municipalities
- Mutual funds: Professionally managed funds that own many stocks and bonds
- Target date funds: Mutual funds that shift from stocks to bonds as a specific retirement date approaches
- Exchange-traded funds: ETFs are baskets of stocks and bonds that are structured like mutual funds but trade like stocks
In addition to these mainstream investments available through most banks, brokerage firms and mutual fund companies, there are additional IRA investment options that are allowed by the IRS. These other investment options are available in self-directed IRAs through self-directed IRA custodians.
For more information on self-directed IRAs and the additional investment options available in these accounts, check out our ultimate guide to Self-directed IRAs.
IRA Variations: Roth IRAs & Rollover IRAs
In addition to traditional IRAs, there are other kinds of IRAs that aren’t employer-sponsored retirement plans, meaning that anyone can set up an account. For example, anyone can set up a rollover IRA to move funds from a 401(k) or another retirement plan. If you meet requirements, in addition to a traditional IRA you can also set up a Roth IRA with after-tax contributions.
A Roth IRA is an account that allows for post-tax contributions, meaning you’re not able to conduct contributions when you file your taxes. Instead of getting the initial benefit of a tax deduction you get to withdraw money from a Roth IRA tax-free after you reach age 59 1/2. Like traditional IRAs, your account also grows tax-free.
Roth IRAs have more limited eligibility and allow for up to $6,000 in contributions based on your age and income level.
A rollover IRA is an account that allows pretax contributions up to the traditional IRA limits. However, Rollover IRAs are more commonly used to move funds from a 401(k) or other employer-sponsored plans after you’ve left the company, which is because Rollover IRA investment options are typically more extensive than a 401(k).
For more information on how these retirement accounts compare, be sure to check out our article on the Best Small Business Retirement Plans.
Traditional IRA Contribution Limits 2019
IRA contribution limits for 2019 are typically $6,000 but can vary based on several factors. If you’re age 50 or older, you’re allowed another $1,000 in catch-up contributions, bringing your total to $7,000. However, if you qualify for a retirement plan at work or exceed certain income thresholds, your contributions limits can also change.
You can learn more in the Traditional IRA Income Limits section below about how your IRA limits may be impacted if you’re eligible for a retirement plan at work.
Current Traditional IRA Annual Contribution Limits
|Annual Catch-Up Contribution Limit (age 50 and older)|
If you’re working on your own or don’t have current employees, setting up a traditional IRA with TD Ameritrade requires no money to open the account, online tools for investing your funds, and trades that cost $6.95 each. To get started simply go online to setup your account and begin your contributions.
IRA Contribution Limit Comparison
|Type of Plan|
|SEP IRA or Solo 401(k)|
Traditional IRA Income Limits
Traditional IRA limits are relatively straightforward for those who don’t qualify for an employer-sponsored retirement plan. However, if you or your spouse qualify for an employer-sponsored plan through your work, then specific IRA limits vary based on your income and the contributions you make to retirement accounts through work.
|Tax Filing Status|
|Single||Full deduction if modified adjusted gross income (MAGI) is less than $64,000|
Partial deduction if MAGI is $64,000-$74,000
No deduction if MAGI is more than $74,000
|Full deduction with no traditional IRA income limits|
|Married Filing Jointly||Full deduction if household MAGI is less than $103,000|
Partial deduction if household MAGI is $103,000-$123,000
No deduction if household MAGI is more than $123,000
|Full deduction with no traditional IRA income limit if spouse doesn't participate in a retirement plan at work|
Full deduction if spouse participates in a retirement plan at work and MAGI is less than $193,000
Partial deduction if household MAGI is $193,000-$203,000
No deduction if household MAGI is more than $203,000
|Married Filing Separately||Partial deduction if MAGI is $10,000 or less||Full deduction with no traditional IRA income limit if spouse doesn't participate in a retirement plan at work|
Partial deduction if spouse participates in a plan at work and MAGI is $10,000 or less
Traditional IRA Contribution Deadlines
To avoid paying taxes or penalties, it’s important to meet traditional IRA contribution deadlines. Thankfully, traditional IRAs are extremely easy to establish and maintain relative to other retirement accounts. The only real deadlines are related to when you need to have the account established and when you need to have made any contributions.
The two main traditional IRA deadlines are:
1. Account Formation Deadline: Tax Filing Deadline for Effective Year
You do not need to set up an IRA in the same year that it becomes effective. However, you are required to have the account established before the deadline for filing your tax returns for that year. If, for example, you wanted to set up a traditional IRA that would be effective for 2019, you would need to establish the account before April 15, 2020.
2. Annual Contribution Deadline: Tax Filing Deadline for that Year
Traditional IRA contributions don’t have to be made during the calendar year that you claim them as deductions. As with account formation, contributions for a given year must be made before your tax filing deadline for that year, which means that you can make “prior year” contributions for 2019 anytime between January 1 and April 15 of 2020.
Traditional IRA Account Rules
In addition to traditional IRA income limits, it’s important to follow certain traditional IRA account rules. Failure to follow these rules, such as taking early withdrawals, cause you to incur penalties or unexpected tax liability. Account holders must also follow age limitations and take required minimum distributions when necessary.
The six primary traditional IRA account rules include:
1. Deduct Contributions from Taxable Income
One of the most significant advantages of a traditional IRA is that it gives you the opportunity to save pretax dollars, which means that any IRA contributions for a given year can be deducted from your taxable income and reduce your tax liability.
2. No Traditional IRA Withdrawals Until Age 59 1/2
The one drawback is that you aren’t allowed to take money from an IRA until age 59 1/2 without paying taxes and early withdrawal penalties. The IRS provides certain exceptions when you’re allowed to tap IRA assets before age 59 1/2 but, generally, you should expect to leave any in any money that you put in an IRA until you reach retirement age.
3. Take RMDs
Once you reach age 70 1/2, you’re required to start taking required minimum distributions (RMDs) from any qualified retirement accounts that you have including traditional IRAs. These required distributions vary based on the size of your retirement accounts. Withdrawals are taxed as income, although your tax rate should be lower when you take withdrawals if you’re no longer working.
4. Don’t Exceed Contribution Age Limit
If you’re eligible for a traditional IRA, you are still allowed to contribute after you reach 59 1/2, which is the age when you can start taking withdrawals without paying penalties. However, you aren’t allowed to make any contributions after you reach age 70 1/2 when RMDs begin.
5. Traditional IRAs as Supplemental Accounts
If you or your spouse participates in a retirement plan at work, you still may be able to use a traditional IRA depending on your income. In these cases, you can use a traditional IRA to make up for any shortfall if you don’t maximize retirement contributions through your work account.
6. Can’t Borrow Against Traditional IRA Assets
IRS rules prohibit traditional IRA account holders from borrowing against IRA assets or pledging them as collateral for a loan. While it’s possible to borrow against 401(k) assets for 401(k) business funding or other purposes, borrowing against an IRA isn’t allowed.
“An individual is not permitted to borrow from his or her own IRA or that of any direct relative or spouse. The risk of cashing out depends on the type of IRA. For example, if they cash out of a traditional IRA before age 59 1/2, they will pay ordinary income tax and a 10 percent penalty. If after 59 1/2, there is no penalty. A Roth IRA can be cashed without tax or penalty after age 59 1/2. If it is cashed out before then, there may be taxes and penalties, depending on how it was funded and how long the funds resided in the Roth IRA.” — Tom Anderson, President, Retirement Industry Trust Association
For more information on when and how you can use traditional IRAs in addition to employer-sponsored plans, check out the Traditional IRA Income Limits section above.
Who a Traditional IRA is Right For
Traditional IRAs are ideal for people who work on their own, don’t have employees and want to contribute up to $6,000 per year pretax. Traditional IRAs aren’t employer-sponsored plans so people can open an account on their own. However, not everyone can use a Traditional IRA, nor can employers use these accounts for their employees.
Some cases with traditional IRA suitability include:
- Employees who aren’t eligible for employer plan: Workers who are part-time or not yet eligible for a 401(k) should consider a traditional IRA to make tax-deferred contributions
- Full-time employees whose spouse isn’t covered by a retirement plan: If you have a retirement plan at work, but your spouse isn’t eligible for a plan, your spouse may be able to make traditional IRA contributions for additional tax-deferred savings
- Freelancers: If you do work for many clients on a contract basis, then you can use a traditional IRA to help save for retirement; however, if you do enough work for any of your clients to qualify for their employer-sponsored retirement plan, your traditional IRA eligibility may be limited
- Solopreneurs: If you have one or more companies but don’t have a lot of employees, a traditional IRA may be an easy and cost-effective way to start saving up to $6,000 per year for retirement; you can use a traditional IRA even if you have employees, but the employees will have to set up their own IRAs if they choose
- Startup founders: Young companies often don’t have a lot of profits to distribute to owners or employees, which means that larger or more expensive retirement plans often don’t make sense; instead, a traditional IRA can give each owner or employee the opportunity to make tax-deferred contributions to an account and invest on their own
- Business owners without employees: If you have a small business and rely predominantly on freelancers, contract labor or part-time workers who wouldn’t qualify for an employer-sponsored retirement plan, you can use a traditional IRA to contribute some savings for your own retirement; if you ever do hire employees, you can always set up a 401(k) or SIMPLE IRA later to offer matching contributions for employees
Traditional IRA Costs
Traditional IRAs are very inexpensive to open and administer if you invest in mainstream assets. Most traditional IRA costs are investment-specific or trading-related costs along with fees for a custodian holding the account. If you invest a traditional IRA in alternative assets, such as a Self-directed IRA for Real Estate, you’ll pay additional charges.
Some typical traditional IRA costs include:
- Custodian Fee ($20-$50 annually): Qualified financial institutions typically charge to hold IRA accounts
- Fund expense ratio (0.05%-1.5% per year): Each mutual fund ETF charges its own expense ratio that’s used to cover trading and management expenses within the fund
- Trading commissions ($5-$50 per trade): Investors who actively trade stocks, bonds or other securities will pay a fee on each transaction
Top Traditional IRA Providers
If you want a traditional IRA, the first step is to pick a provider who offers the investment options that you want. Many banks offer IRAs but most limit investments to certificates of deposit (CDs) and other low-interest investments. If you want to invest for growth while keeping your costs low, consider brokerage firms and mutual fund companies.
Some of the top traditional IRA companies include:
Vanguard is the largest and one of the oldest mutual fund companies in the world. It is an excellent mutual fund management company and has a reputation for providing well-managed funds at an extremely low cost. If you want to stick to passive mutual fund investing in your traditional IRA, Vanguard is worth considering.
Fidelity is a huge diversified financial services company. It offers banking, brokerage and investment advisory services as well as its own line of mutual funds and ETFs and a nationwide network of advisors who can provide individual guidance. A Fidelity Traditional IRA is ideal if you want a cost-effective provider with an extensive menu of offerings and access to advisors who can help you one on one.
Schwab is another large diversified financial services company. The firm offers a full array of banking services in addition to securities brokerage and investment advisory services. Like Fidelity, Schwab also has a vast network of offices, although they don’t have quite a large a network as Fidelity. If you think you may want banking services in addition to your traditional IRA, be sure to check out Charles Schwab.
E-Trade started as an online discount brokerage firm and that service remains at the center of its operations today. E-Trade is still a great discount brokerage firm that offers very cost-effective trading in stocks, bonds, options and other securities. The firm is ideal if you want to actively trade individual stocks, bonds or ETFs in your IRA.
TD Ameritrade is another good option if you’re looking for a reputable online trading platform. Like Fidelity and Charles Schwab, TD Ameritrade also has a network of offices around the country, although they aren’t present in as many markets. Nevertheless, if you want to trade in your IRA online and get access to advisors who can help you, be sure to check out TD Ameritrade’s offerings.
How to Set up a Traditional IRA in 3 Steps
A traditional IRA is the least-complicated retirement account to establish and maintain. While it offers all of the advantages of tax-deferred savings and investing, setting up a traditional IRA requires choosing a provider and filling out some forms. After your account is set up, it’s effortless contribute and annual administration is minimal.
The three necessary steps to set up a traditional IRA include:
1. Choose a Traditional IRA Custodian
The most critical step to establishing a traditional IRA is picking a provider that offers the investment options and cost structure that are consistent with your investment strategy and objectives. Whether you want to trade stocks or buy-and-hold mutual funds actively, pick a provider that’s good for what you want.
2. Open a Traditional IRA Account
Once you’ve settled on a provider that’s consistent with your investment style and goals, you need to complete some forms including an account application to set up your traditional IRA. These forms can often be completed online and are usually processed relatively quickly. For a traditional IRA, there are no notices that you need to file with the IRS or other paperwork.
3. Make Traditional IRA Contributions
Once you’ve completed your account application and your traditional IRA is established with your chosen provider, the only thing left to do is to make regular, pretax contributions to your account. For a traditional IRA, there no required annual filings except for reporting tax-deductible contributions or taxable distributions on your personal tax return.
Pros & Cons of a Traditional IRA
In deciding whether to use a traditional IRA, there are advantages and drawbacks to be considered. Traditional IRAs provide offer tax-deferred savings but also require you to leave money in until age 59 1/2 or pay early withdrawal penalties. You also may be ineligible for an IRA if you get retirement benefits through work.
Pros of a Traditional IRA
Some traditional IRA pros include:
- Pretax contributions: In an IRA you can contribute money before you pay income tax on those earnings
- Tax-deferred growth: Once you’ve made contributions to an IRA, you can invest those contributions and your account grows without taxes on interest or capital gains
- Creditor protection: Assets held in an IRA are held in trust and, therefore, protected against creditors or in bankruptcy
- Easy setup and administration: Incredibly easy to form, contribute and maintain
Cons of a Traditional IRA
Some traditional IRA cons include:
- Penalties for early withdrawals: If you take money out of an IRA before age 59 1/2 you will be penalized unless you mean certain circumstances outlined by the IRS
- Limited investment options: There are only certain things that you can invest in with an IRA, even if you have a self-directed account
- Taxes on withdrawals: While you get tax deductions in the years you make contributions, you must pay income taxes when you take IRA withdrawals
- Required minimum distributions: Starting at age 70 1/2 you’re required to start taking money out of any qualified retirement accounts that you have including IRAs
- Limited eligibility: You may not be able to use a traditional IRA if you or your spouse is eligible for a retirement plan at work
Alternatives to a Traditional IRA
A traditional IRA is extremely simple and cost-effective to set up and maintain, but it isn’t right for everyone. Many small business owners use other types of accounts to contribute more each year or to provide profit-sharing or matching contributions to full-time employees who qualify for retirement benefits with their company.
Six of the leading traditional IRA alternatives for small businesses include:
The 401(k) is the gold standard for small business retirement plans. A 401(k) allows you to incentivize employee saving by matching contributions as well as reward key employees by sharing profits. A properly structured 401(k) plan can also let a plan participant borrow against retirement assets — something that’s not allowed with IRAs.
A 401(k) is much more complicated to set up or administer than an IRA. However, the right provider can make the process much easier for a small business owner. To find a provider who works well for your business, be sure to check out our list of the best 401(k) companies.
A 403(b) is a tax-deferred annuity plan that’s similar to a 401(k), except that only certain tax-exemption organizations can use it. 403(b)s are commonly used by charities, churches, public school systems and government agencies. These plans allow employees to make tax-deferred contributions to invest in things like mutual funds and target date funds.
If you work at a tax-exempt organization like a church or philanthropy, you may be eligible for a 403(b) plan. If you aren’t maximizing contributions, you may also be able to set up a traditional IRA. However, 403(b) plans usually allow for employer contributions to employee accounts, similar to 401(k) matching or profit sharing.
3. SEP IRA
A simplified employee pension (SEP) IRA is a retirement account that’s common among small, highly profitable businesses. Annual contribution limits to SEP IRAs are $56,000 rather than $6,000 for traditional IRAs. However, in a SEP IRA, an employer is required to fund contributions for all employees proportional to any contributions the employer makes for themselves.
Because of the requirement that employers fund all contributions for employees, SEP IRAs are ideal for small businesses that have very few or no full-time employees. More information on SEP IRAs be sure to check out our article on SEP IRA Rules, Contribution Limits & Deadlines.
4. SIMPLE IRA
Savings incentive match plan for employees (SIMPLE) IRAs are similar to 401(k)s with employees making contributions and employers matching those contributions The most significant difference in a SIMPLE IRA is employers are required to match employee contributions up to 3 percent. Employers can match less than 3 percent but not for more than two years in a five-year period and never less than 1 percent.
A SIMPLE IRA works very much like a 401(k), so it’s typically ideal for small business owners who have a few employees and want to incentivize employee saving but still want a more cost-effective option than a Traditional 401(k). To learn more, check out our article on SIMPLE IRA Rules, Contribution Limits & Deadlines.
5. Roth IRA
Unlike a traditional IRA or the other alternatives above, contributions to a Roth IRA are not tax-deductible. If you meet specific Roth IRA eligibility criteria, you may be able to contribute to a Roth IRA in addition to a traditional IRA or one of the other alternatives listed here.
Total annual contributions to traditional IRA s and Roth IRAs are limited to $6,000, which means that if you contribute to a Roth IRA, you won’t be able to contribute as much to a traditional IRA. However, while Roth IRA contributions are not tax-deductible, they grow tax-free and can be withdrawn tax-free during retirement.
A Keogh Plan is one final alternative to Traditional IRAs that can be helpful for self-employed individuals. While Keogh plans used to be very common among self-employed business owners (as an alternative ot SEP IRAs), they aren’t used very much anymore. To learn more, be sure to check out our article on Keogh Plans.
6. Self-Directed IRA
A self-directed IRA is a tax-deferred individual retirement account that allows you to invest in more diverse assets than those offered by a traditional IRA. Without the limitation of investing in a predetermined menu of mutual funds, you are able to pursue opportunities in real estate, venture capital, startups and private companies, and various stocks and bonds. They offer the same tax benefits as other IRAs and have annual contribution limits of $6,000 ($7,000 if you’re 50+ years old).
Reach out to a reputable provider, such as Rocket Dollar, to invest with speed and confidence in the assets that you want. No more asking your custodian for permission, or having to navigate a long list of fees. Rocket Dollar can get you set up for a $360 registration fee plus $15/month. Opening an account online takes less than 10 minutes.
The Bottom Line
A traditional IRA is a straightforward, cost-effective investment account that’s easy to setup and administer. Unlike employer-sponsored retirement plans, anyone who qualifies can establish a traditional IRA to start making pretax contributions. Once you’ve decided to open an account, it’s important to pick a provider whose investment options and cost-structure suit your needs and investment strategy.
If you’re searching for an up front, low cost, traditional IRA, consult with the team at TD Ameritrade. With TD Ameritrade, opening a traditional IRA account requires a $0 opening deposit, and costs only $6.95 per online equity trade.