A traditional IRA is a tax-advantaged account where you can invest for retirement. You can
receive a tax deduction for all or part of your contribution when you file your taxes if you
You also won’t need to pay taxes on any earnings in the traditional IRA until you take a
withdrawal. You can take a withdrawal from the traditional IRA at any time, but if you do so
before age 59 ½, you may have to pay an additional 10% tax penalty, with the exception of
qualifying life events.
This tax strategy could potentially benefit those who estimate they will be in a lower tax
bracket when they enter retirement, as the traditional IRA tax deduction could help you defer
taxes until you make withdrawals in retirement.
Conversely, if you think you’ll be at a higher tax bracket near retirement, the Roth IRA could
potentially be a better option. That’s because, unlike the traditional IRA, you pay taxes on all
contributions to your Roth IRA, but don’t pay taxes on Roth IRA withdrawals after age 59 ½.
Read on to learn more about how a traditional IRA works.
How the traditional IRA works
The traditional IRA (individual retirement account) gives investors a chance to put money away into stocks, ETFs and other securities they choose. The appreciation and dividends you earn from your individual IRA investments can remain and grow in the account tax-free. Once you begin taking distributions, they will be then taxed based on the individuals income tax bracket.
The traditional IRA can potentially help you defer your tax burden by letting you claim a tax
deduction on contributions, if you qualify.
Traditional IRAs let you invest thousands each year. Contributions may be tax-deductible and could grow tax-free. (Distributions taxed as income.)
This account is accessible to anyone as there are no income restrictions to open and fund this type of IRA. However, there are limits to how much you can contribute to a traditional IRA
each year. In 2023, the total amount you can contribute across all your traditional IRAs and
Roth IRAs combined is:
• Under 50 years of age: $6,500
• Over 50 years of age: $7,500
Additionally, you must begin taking required minimum distributions (known as RMDs) when
you turn 73 years old with traditional IRAs. Lastly, you have roughly 15.5 months to fill your
yearly contributions. For example, you have from January 1, 2023, until April 15, 2024 (Tax
Day), to fill your traditional IRA for 2023.
Learn more about IRA contribution limits.
Traditional IRA early withdrawal rules
Life happens, and there may be an instance where you need to dip into your retirement fund.
It’s not an ideal option as there are penalties for doing so.
If you pull any funds from your traditional IRA before you’re 59 and a half years old, the
amount will be added to your gross income tax for the year plus an additional 10% tax penalty.
However, there are exceptions where you can pull funds out from a traditional IRA without
incurring a tax penalty, including:
• A first-time home purchase (on first $10,000 of distributions)
• Qualified education expenses
• Birth or adoption expenses (on first $5,000 of distributions)
• Unreimbursed medical expenses or health insurance if you’re unemployed
• If you become disabled
Additionally, your estate can make a withdrawal from your traditional IRA without incurring
the 10% tax penalty if you pass away.
How to fund a traditional IRA
It’s likely that if you participate in an employer-sponsored retirement account, they take your
funds out of your paycheck for you. In this case, you will take the money you are paid post-tax and contribute to your traditional IRA. If you qualify, you will be given a tax write-off.
To get started, you can open a traditional IRA account in the M1 app or on our website. Once
you select the type of account you want, there’s only a few more steps:
• Fund your account from your bank account
• After that, choose the securities you’d like to purchase within the account (I.e., stocks,
ETFs, etc.) and invest the funds you deposit
Tip: Millions of Americans have uninvested funds in their individual retirement accounts. It
might not be enough to just put money in your account — for accounts you manage yourself,
like IRAs, you have to purchase securities to have your funds “invested”.
And after that, you’re done. Just be sure that when you file your income tax returns to claim
the amount you contributed as a tax deduction.
The M1 bottom line
A traditional IRA valuable option for investors who want to defer their tax liability until
later on in life. If you’re looking to maximize your tax strategy, consulting a licensed tax
professional is recommended.
M1 and its affiliates do not provide tax, legal, or accounting advice. This material has been
prepared for informational purposes only. It is not intended to provide, and should not be
relied on for, tax, legal or accounting advice. You should consult your own tax, legal, and
accounting advisors before engaging in any transaction.