5 Things You Need to Know About The Traditional IRA 2014

traditional ira rules and limitsYou know how much I love the Roth IRA.  Love, love, love it!!

I’m actually more in love with the Roth IRA than I am the 401k.

And you already know how I feel about target date mutual funds.  <blah!>

But what about the Traditional IRA?  Does it still have it’s place in your retirement plan? You betcha!!

If you are fortunate to work at a company that offers a match on your 401(k) deposits, don’t walk away from that free money. There, however, might be some instances where the traditional IRA has its place.

Here’s a closer look at some of the rules of the Traditional IRA Account.


1. Contribution Limits for 2014

If you are under the age of 50, the maximum amount of money you are allowed to contribute to a Traditional IRA in 2014 is $5,500 (which is the same for 2013). You can contribute this amount regardless of whether you are eligible to claim a deduction for using a Traditional IRA.

But if you are over the age of 50, the IRS allows an additional contribution, often referred to as a “catch-up contribution,” up to $1,000. So if you already celebrated the big “5-0″, you can contribute a total of $6,500 to a Traditional IRA.

Contribution YearAge 49 and BelowAge 50 and Above (Catch UP)
2006-2007$4,000$5,000
2008$4,000$5,000
2009$5,000$6,000
2010$5,000$6,000
2011$5,000$6,000
2012$5,000$6,000
2013$5,500$6,500
2014$5,500$6,500

2. Traditional IRA Account Phaseout Limits

Now, let’s review the traditional IRA phaseout limits, the income levels at which you are allowed to take the deduction for an IRA. Note these limits kick in only if you have a retirement plan (401(k), 403(b), etc, but not a defined benefit plan) at work, whether or not you actually contribute to it.

If you are single, the 2014 phaseout is $60,000-$70,000, for married filing joint, $96,000-$116,000. Below the lower figure in that range, you may deduct the full amount of $5,500 if you are under 50 or $6,500 if you turned 50 in or before 2014.

The amount you may deduct decreases linearly until the higher number of that range is reached. If you find you are just beyond these ranges, you’ll qualify to put money you can’t deduct into a Roth, instead of just putting after-tax money into the traditional IRA.

Next, I’ll discuss the potential advantages and disadvantages of using the IRA in favor of the (non-matched) 401(k).

3. 401k vs. Traditional IRA- Which one rules the roost?

The 401(k) can excel in two regards. If you separate from the company at 55 or older, you can take withdrawals penalty-free. Of course, taxes are still due, but no penalty, as with an early IRA withdrawal. The 401(k) also offers the ability to borrow from the account. This can be a mixed blessing, and potentially risky move, but an option nonetheless.

IRA advantages start with low cost and flexibility. The costs within a 401(k) account are often tough to understand and often multi-layered, a potential combination of management fees as well as expenses for the underlying investment. For small plans, fees can easily run above 1.5% and even over 2%.

Considering that your goal is to save money pre-tax at one rate and upon withdrawal, pay taxes at a lower rate. This advantage can disappear altogether in a decade with fees approaching 2% per year. With few limitations on what you may invest in within an IRA, you are free to choose from investments with very low expenses, many index based investments offer fees as low as .10%, a fraction of the average 401(k) expense.

The rules of the traditional IRA offer a penalty-free, but not tax-free withdrawal of up to $10,000 per person for the first time purchase of a new home. ‘New’ to the IRS just means that you didn’t own your principal residence during the prior two years, not that you never owned a home. You can also use this penalty-free withdrawal to help a child, grandchild, or parent.

A similar penalty-free withdrawal is also allowed for qualified higher education expenses for you, your children or grandchildren. Expenses include tuition, fees, room and board, books and supplies.

There is also an exception for withdrawal made to cover medical expenses exceeding 7.5% of your adjusted gross income.

If you are fortunate enough to be able to retire before age 59-1/2, you have an option called a Section 72(t) withdrawal. You are permitted to take withdrawals from your IRA that follows a

“Series of substantially equal periodic payments (SOSEPP)”.

Once you begin this process, you must continue this exact withdrawal amount for 5 years or until age 59-1/2, whichever comes later. The choices for calculating that periodic payment are minimum distribution, amortization, and annuitization. Further details on this is available at the IRS web site.

4. Beneficiary Check

When opening up an IRA, or if you already have one, be sure to specify your beneficiaries. An IRA that doesn’t not have a designated beneficiary will become part of your estate and regardless of who inherits it, has limited options to continue its tax-deferred status. By specifying a beneficiary, and ideally a contingent beneficiary, your heir(s) can take withdrawals over their remaining lifetimes.

5. Where to Open a Traditional IRA

traditional ira rules and contribution limits If you aren’t sure which broker to use to open a Traditional IRA, we’ve done an IRA broker comparison for you.

The IRA has been around since 1974 and with good reason, it deserves a place in your finances as the core of your long term retirement planning.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

 

Photo by Jason York Photography

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Comments | 9 Responses

  1. scs00 says

    I’m wondering what you meant by the following sentence. My wife and I (married, filing jointly) make more than $112k. Are you saying that we are instead eligible for the Roth IRA since we make more than the highest threshold number? Thanks for the clarification!

    “If you find you are just beyond these ranges, you’ll qualify to put money you can’t deduct into a Roth, instead of just putting after-tax money into the traditional IRA.”

    • says

      @scs00 You actually qualify for both. What the comment was alluding to is if both you and your spouse are covered by 401k plans at your work. If so, then can still contribute to a traditional IRA; you just won’t get any tax deduction.

      That’s why most people will generally lean towards a Roth IRA. Remember that the Roth IRA also has phaseout limits. You can find more on the Roth IRA rules here:

    • Jeff Rose says

      You actually qualify for both. What the comment was alluding to is if both you and your spouse are covered by 401k plans at your work. If so, then can still contribute to a traditional IRA; you just won’t get any tax deduction.

      That’s why most people will generally lean towards a Roth IRA. Remember that the Roth IRA also has phaseout limits. You can find more on the Roth IRA rules here: http://www.goodfinancialcents.com/roth-ira-rules-contribution-limits/

  2. says

    Great post. I didn’t realize there was an option to withdraw funds from an IRA early with no penalty providing you commit to an equal withdrawal schedule for 5 years. One of my main reluctance with an ira was that I wold get slugged a withdrawal tax when I wanted to retire and live off my dividends early (say by 40-45 or so). I didn’t realize there was an option to take this out in equal payments.

  3. Brian says

    @Integrator:

    If you were wanting to live off of dividends, you would probably be better using a taxable account (or a ROTH) since withdrawls from a Traditional IRA are at your normal tax rate versus the much more favorable dividend rates. Of course I am not an advisor, but that is something to consider.

  4. Rick A. Ward says

    Can I continue to contribute to my IRA account if I am retired? I am not receiving any income from my IRA at this time. I am receiving social security and retirement benifets from my teacher retirement accounts which are both taxable incomes.

    Rick A. Ward

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