WHAT ARE THE TAX ADVANTAGES OF A TRADITIONAL IRA?
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In many cases, the contributions you make to a traditional IRA can be deducted from your taxable income. This is one of the popular attractions of these retirement accounts.
deduct IRA contributions, you subtract them from your taxable income for the year you made them. For instance, let us say you earned $23,000 this year. Let us also say that you contributed $3,000 to your traditional IRA. You can deduct that amount, leaving you with $20,000 on which to be taxed. There is, however, an
income limit after which you cannot deduct the full amount.
If you find that you do not qualify for deductibility, you can still contribute to a traditional IRA. In this case, yours would be a non-deductible IRA.
If you are married and you or your spouse is not working or has earned only a minimal income, either of you may set up what is called a spousal IRA. As long as one spouse has earned income at least equal to the total amount you contribute for both spouses, each of you may set up an IRA. For
2005, a maximum of $4,000 may be contributed to each account. The law also allows each taxpayer age 50 and older to make an additional "catch-up" contribution of $500 for each of those years. By 2008, the regular IRA contribution limit will reach $5,000 per year, with an extra $1,000-per-year "catch-up" for those over 50.
In a traditional IRA, any dividends and capital appreciation that accrue to your account are tax-deferred. That means that the government cannot tax them until you withdraw them. For instance, if your IRA earns $100,000 over the years, that $100,000 will not be taxed until you withdraw it.
savings, tax-deductible contributions, and tax-deferred earnings are three
reasons for the enduring popularity of the traditional IRA among many investors.
There are limits on deductibility, and they may affect you. We will cover them next.