An Introduction to Traditional IRA Rules

Author: Steven posted in Retirement planning tagged with Traditional IRA

Although traditional IRAs can be appropriate vehicles to help build tax­-sheltered capital for your retirement, they come with some rules and restrictions that you should be aware of before you start investing in them. We recommend you review the rules on the IRS website to see how they apply to your individual situation.

First of all, an IRA is considered a cash account and not a margin account. This means that all the investments you make in an IRA must be through cash deposited in the IRA. You cannot take advantage of using leverage via a margin account to boost the profits (borrowing money is not allowed). Personally I’m not a fan of margin accounts because they act like a double-­edged sword, if the market is going down you can suffer a large (amplified) potential loss.

IRA accounts do not allow you to invest funds in either life insurance or collectibles (such as artwork, antiques, gems, etc).

Although you are allowed to withdraw money from your traditional IRA at any time, you need to consider that you will have to pay income tax on the amount withdrawn and if you are less than age 59 ½ you will also have to pay an early withdrawal penalty of 10% of the amount withdrawn.

Traditional IRAs have mandatory required minimum distributions (RMDs) starting at age 70 ½. Not taking the mandatory distribution will result in a 50% penalty on the amount you should have taken.

When contributing to a traditional IRA, you should be aware of the yearly contribution limits which are $5,000 ($6,00 if you are age 50 or older). If you are married, then both you and your spouse can contribute up to the limit. You must have earned income of at least equal to the amount you are contributing to the IRA, unearned income from things like pensions and dividends doesn’t count.

In addition to the yearly contribution limit, there is also an income limit on making contributions so make sure you do not contribute if you are above the IRS limit. Contribution limits change over time due to inflation and also depends on whether you have a workplace retirement plan so always make sure you are up­-to-­date by checking the IRS website.

Once you turn 70 ½, you are no longer allowed to make contributions to a traditional IRA. This rule does not apply to Roth IRAs, making them a great wealth-­transfer instrument.

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