A traditional IRA can be an excellent retirement savings tool, particularly if your earnings are too high for you to contribute to a Roth IRA or you don’t have the opportunity to invest in a 401(K).
A traditional IRA allows your retirement contributions to grow tax-free, and in many circumstances your contributions to the account are tax deductible, too.
There are some limits to the amount you can contribute to a traditional IRA in any given year. First, you can only contribute up to the amount of your earned income for the year in question. Interest and other unearned income don’t count. Second, your contributions are capped at $5,000 for 2011 (that number increases to $6,000 if you’re 50 or older).
In many cases, the contributions you make to a traditional IRA are tax deductible. And regardless of whether or not your contributions are tax-deductible, the earnings on your contributions are tax-deferred. This means that your account balance can grow without any income taxes until you begin withdrawing funds from the account – preferably after you reach age 59 ½.
Starting in the year after you reach age 70 1/2, you’ll be required to withdraw a minimum amount from your account each year. This is what’s known as a Required Minimum Distribution (RMD), and the amount varies from person to person and from year to year. The IRS determines the amount of your annual RMD on the basis of your age and your IRA balance.
One final note about making contributions to a traditional IRA, for any given year, you can start making contributions on January 1, and you have until the following tax day to contribute the maximum. So, if you haven’t maxed out your 2010 contributions yet, you have until April 18, 2011 to do so.