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What Is a Traditional IRA? Eligibility, Tax Benefits and How It Works

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What is a
Traditional IRA?

A traditional IRA is an individual retirement account that enables the growth of your earnings without immediate tax obligations. Taxes are only levied on the investment gains when you make withdrawals during your retirement years, allowing for potential tax savings and the accumulation of funds for your future financial security.The money you place in a traditional IRA goes towards your retirement and can be invested in various places, such as stocks, bonds, or real estate. Traditional IRAs are held and handled by a custodian.

Key Features

  • Annual contribution limit of $7,000 for 2025 (if under 50)
  • $1,000 catch-up contribution allowed if age 50 or older
  • Tax-deferred growth on all earnings
  • Potential tax-deductible contributions, based on income and employer plan status
  • Required Minimum Distributions (RMDs) begin at age 73
  • 10% early withdrawal penalty if funds are taken out before age 59½ (exceptions apply)
  • Broad access to stocks, bonds, ETFs, and mutual funds through standard custodians
  • Must comply with IRS contribution and withdrawal rules

Eligibility

Anyone can open a traditional IRA account. However, for tax deduction, not everyone is eligible. Tax deduction on the contributions depends on your income status.

According to the latest MAGI (modified adjusted gross income) 2025, there are full deductions if a retirement plan at work covers you and your income is less than $79,000. There is a partial deduction if your income is more than $79,000 and less than $89,000. And you won’t see any deductions if your income is more than $89,000.

How to Open an Account

You can open a traditional IRA account in two ways:

  • 1

    Brokers

    An investment broker is great if you make investments yourself. They can give you options of what is available in their services like mutual funds, bonds, stocks, etc.At SD Retirement Plans we can guide you through your entire retirement planning process and offer some personalized solutions!

  • 2

    Robo-advisors

    These advisors are equipped with all the recognizable investing names. All you have to do is feed in your investing needs and goals, and they will come up with the best options for you.

How to Fund the Account

There are three main ways to fund your Traditional IRA:

Transfer

Move funds between IRAs of the same type—for example, Traditional IRA to Traditional IRA.

  • Tax-free and penalty-free when processed correctly
  • Common when switching custodians or institutions
  • Must be between like accounts only (e.g., Traditional to Traditional)
  • No IRS reporting required if done properly
  • Unlimited transfers allowed each year

Rollover

Shift funds from another retirement account—like a 401(k), 403(b), or another IRA—into your Traditional IRA.

Direct Rollover
  • Funds move directly between institutions
  • No taxes or penalties incurred
  • Recommended method for simplicity and compliance
Indirect Rollover
  • You receive the funds personally and must re-deposit within 60 days
  • Only one indirect rollover per 12-month period is allowed (per person)
  • Late deposits may result in taxes and penalties

Contributions

Make regular yearly contributions using earned income.

  • $7,000 limit for 2025 (under age 50)
  • $1,000 catch-up allowed if 50 or older
  • Contributions may be tax-deductible depending on income and workplace retirement coverage

IRS Rules

You can start tapping from your traditional IRA account after you reach 59 ½. You need to pay regular income tax on the withdrawals.

Early withdrawal of funds from your traditional IRA will result in a 10% penalty. This won’t happen if you come under exceptions like needing money to buy house or college fees.

Just because you hit the retirement age does not mean you have to start tapping from your IRA account. You can wait till you reach the required minimum distributions age, 73.

Rollovers

Rollovers to
a Traditional IRA

Yes, you can roll over funds from various retirement accounts into a Traditional IRA. Here's how it works by account type:

  • Traditional IRA

    Can be rolled over or transferred without triggering taxes

  • SEP IRA

    Eligible for full rollover into a Traditional IRA

  • SIMPLE IRA

    Can be rolled over after two years of participation

  • 401(k), 403(b), or 457(b)

    Eligible for rollover if you've left your employer or meet qualifying conditions

  • Roth 401(k)

    Can only roll over into a Roth IRA, not a Traditional IRA (consult a tax advisor)

  • Inherited Accounts

    Special rules apply—consult a tax advisor before rolling over inherited IRAs

Rolling funds into a Traditional IRA allows you to consolidate your retirement savings under one account and continue tax-deferred growth.

Rollovers from
a Traditional IRA

You can also roll over funds out of your Traditional IRA into another qualified retirement account. Here's how the process works:

  • 60-Day Rule

    If you receive the funds personally, you must redeposit them into another IRA or eligible plan within 60 days to avoid taxes and penalties

  • Direct Rollover

    The preferred method—your IRA custodian sends the funds directly to the new provider, avoiding immediate tax implications

  • Rollover to Another Traditional IRA

    Useful when switching custodians or consolidating accounts

  • Rollover to a 401(k)

    Allowed if your new employer’s plan accepts incoming roll-ins from Traditional IRAs

Done properly, rolling over a Traditional IRA helps you stay tax-compliant while realigning your investments or consolidating multiple accounts.

Who is it For?

W-2
Employees

Looking to build retirement savings with potential tax deductions and no access to employer-sponsored plans.

Tax-Conscious
Savers

Wanting to reduce their taxable income today through deductible contributions (subject to income limits).

Those Expecting Lower Taxes in Retirement

Planning to pay less in taxes when they withdraw, making pre-tax contributions more valuable now.

Older Workers Nearing Retirement

Seeking a reliable way to catch up on retirement savings with higher annual contribution limits (age 50+ catch-up).

New
Investors

Getting started with retirement savings and wanting a simple, tax-deferred account with broad investment options.

Common Mistakes to Avoid with Traditional IRA

  • Missing the RMD Deadline

    Failing to take Required Minimum Distributions (RMDs) after age 73 can result in a 50% penalty on the amount you should have withdrawn.

  • Withdrawing Early Without Knowing the Rules

    Taking money out before age 59½ can trigger a 10% early withdrawal penalty-plus income tax-unless you qualify for an exemption.

  • Assuming All Contributions Are Deductible

    Your contribution may not be fully deductible if you or your spouse are covered by a workplace plan and your income exceeds certain limits.

  • Doing More Than One Indirect Rollover Per Year

    IRS only allows one indirect rollover per 12-month period per person, across all IRAs. Violating this can lead to taxable income and penalties.

  • Not Naming a Beneficiary (or Keeping It Updated)

    Neglecting to assign or review your IRA beneficiary could lead to unintended estate complications or delays in asset transfer.

  • Forgetting to Report Nondeductible Contributions

    If you make nondeductible contributions, you must file IRS Form 8606-otherwise, you might pay taxes twice on that money when you withdraw it.

  • Rolling Over to the Wrong Type of Account

    Accidentally rolling a Traditional IRA into a Roth IRA without understanding the tax impact can result in an unexpected tax bill.

Frequently Asked Questions

What to consider before withdrawing from your traditional IRA account?

If you want to avoid the 10% early withdrawal penalty, consider tapping your account after hitting the 59 ½. However, this does not mean you will have to take distributions. l You can wait till you hit the required minimum distributions (RMDs) age.

The IRS usually imposes a 10% penalty for withdrawing funds from your traditional IRA before reaching the age of 59 ½. However, you can avoid this in certain circumstances like:

  • No health insurance with a huge medical bill
  • Unemployed and have health insurance premiums
  • Permanently disabled and are unable to work
  • Fund higher education
  • Inherited an IRA
  • Want to buy, build or rebuild a home
  • SEPP
  • Have unpaid federal taxes
  • Qualified reservist called to active duty
No, a 401(k) is not a Traditional IRA.
A 401(k) is an employer-sponsored retirement plan, while a Traditional IRA is an individual retirement account that you open yourself. Both offer tax-deferred growth, but they have different rules for contributions, withdrawals, and employer involvement.
Yes, you can have both a Roth IRA and a Traditional IRA. However, your ability to contribute to each depends on your income and tax filing status. Keep in mind that the combined annual contribution limit applies across both accounts—for 2025, that’s $7,000 (or $8,000 if you’re 50 or older).
They can be—but it depends on your income and job situation.
If neither you nor your spouse is covered by a retirement plan at work, your full contribution is usually deductible.
If you are covered, your deduction may be partially reduced or phased out based on your income and filing status. The IRS updates these limits each year.

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