Traditional IRAs came about as part of the 1974 Employee Retirement Income Security Act (ERISA). Congress intended the accounts for employees not covered by workplace retirement plans. Over the years, legislation has impacted the rules and regulations that govern IRAs, but the basic tax-related benefits you receive from utilizing a traditional IRA have stood the test of time.
Traditional IRA owners can deduct contributions they make to their accounts, up to an annual limit, from their taxable income. A deduction differs from a tax credit. When a taxpayer receives a credit, his total tax due decreases by the amount of the credit. With a deduction, however, the amount of income the IRS uses to calculate the total tax due gets reduced. For example, if a taxpayer's adjusted gross income stands at $50,000 and he contributes $1,000 to a traditional IRA, the IRS figures his tax due on $49,000, all else being equal.
When a traditional IRA account owner withdraws money from her account, she pays regular income tax on the entire distribution, regardless of her age or situation. This differs from a Roth IRA. With a Roth, account holders do not receive the up-front tax benefit traditional IRAs provide; however, they can remove original contributions at any time tax- and penalty-free.
Early Withdrawal Penalty
Generally, the IRS charges a 10-percent tax penalty on all traditional IRA withdrawals that occur before Uncle Sam's mandated retirement age of 59-1/2. This levy is in addition to the regular income tax due. There are some exceptions to the this rule, which can be found in IRS Publication 590. For example, traditional IRA owners can escape the 10-percent penalty if they access their money prior to retirement after becoming disabled.
Required Minimum Distributions
The IRS requires traditional IRA owners to begin taking money out of their account by April 1 of the year after they turn 70-1/2. The account holder pays regular income tax on these required minimum distributions. If the owner of a traditional IRA fails to take this distribution in a given year, the IRS charges him a 50-percent excise tax on the amount that should have been removed.