Why should I establish a traditional individual retirement account (IRA)?


If you have a stable income and you wish to pay less tax on your earned compensations, you can open a traditional individual retirement account (IRA) and start making annual contributions to it.

Part or all of the IRA contributions will accumulate on a tax-deferred basis and any distributions will be taxed as ordinary income.

Traditional IRA Advantages

  • IRA provides flexibility: you can choose the regularity and amount of contributions. However, bear in mind that the annual IRA contributions are subject to certain limits. For 2009, the maximum annual contribution is $5,000.
  • Workers older than 50, who have not saved enough money, can benefit from the catch-up provisions which allow them to make additional maximum contributions of $1,000.
  • Contributions to a traditional individual retirement plan can be tax-deductible and the earnings are not taxed until they are withdrawn or distributed. Income tax is deferred until retirement when people usually have lower incomes, and hence, they are likely to pay lower taxes than they would have prior to retirement.

Establishing a Traditional Individual Retirement Account

To establish a traditional IRA you need to meet two eligibility requirements:

  • You must have earned income during the year from wages, salaries, bonuses, commissions, self-employed income, or taxable alimony. Note that compensation received from any of the following sources is not eligible for traditional IRA contributions:
    • Investment income;
    • Pension or annuity income;
    • Social Security;
    • Rental income or any property profits.
  • No traditional IRA contributions are allowed for the tax year in which the participant attains age 70 ½.

Traditional IRAs can be established with a financial institution such as a bank, a stock brokerage company, a saving and loan association or a life insurer. You should make sure that the financial organization you are considering opening a traditional IRA with, has been approved by the IRS to sell IRAs.

You can open a traditional IRA anytime but contributions must be made before the due date for filing a tax return for the previous tax year, which is 15 April of the following year.

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