IRAs are a great way to contribute money and save for retirement. As a difference to the tax-free Roth IRA, Traditional IRAs work under a tax-deferred basis so it basically works also as a tool that offers tax benefits now (in the year that you make the contributions) while you save for retirement later
Traditional IRA’s main feature is that all of the money that you contributed throughout the year into the account may lower your taxable income. Another feature of this account is that you may be eligible for a tax credit equal to a percentage of the total contribution which can vary from 10% up to 50%.
The after-tax money you have contributed to the Traditional IRA account will not be taxed when withdrawn, however, you need to keep track of all of these contributions. You may not be able to get the full benefit of an IRA account under certain circumstances such for example if your spouse is already covered by a retirement plan at work or if your income exceeds certain levels. If you and your wife are not covered by a retirement plan at work, then you can take the full deduction only up to the amount of your contribution limit.
The contributions you make into the Traditional IRA as well as earnings that the account may have, are only taxed under two circumstances:
- Early Withdrawal: This occurs when you withdraw money from the account before the date of retirement. These amounts will be subject to full or partial tax in the year you withdraw them.
- Distributions: Once you retire, the money you take out from the account in the form of payments is called “distribution” and they are subject to income tax at the tax rate you would be at that time.
In summary, you may want to consider contributing to a Traditional IRA, as long as you expect to be in a lower tax bracket by time you retire. If not, then you may want to consider contributing to a Roth IRA account, where you don’t get an upfront deduction but the money you contribute to the account will grow tax-free so at the time of retirement, the withdrawals will be tax free.