How to Add Money to a Traditional IRA

How to Add Money to a Traditional IRA
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According to Fidelity Investments, the number of 401(k) millionaires hit 365,000 in the first quarter of 2021, a 143 percent increase from 150,000 a year earlier.

Many more people, of course, are saving for retirement by means of the 401(k), an employer-sponsored plan, and other financial vehicles as well. The traditional IRA, for example, is worthy of consideration by any investor with earned income.

Understanding Traditional IRAs

The number of categories of investment accounts ensures that some, such as the traditional IRA, might be overlooked. This IRA, however, is a powerful retirement-savings tool you can open at a brokerage or a bank.

Unlike the Roth IRA, you can contribute to a traditional IRA regardless of your income levels, assuming that you meet other criteria, including that pertaining to earned income. The best traditional IRA will vary from person to person, but many have the same features and investment options.

Traditional IRA Contributions

The Internal Revenue Service sets the maximum allowable contributions to a traditional IRA. For 2021, the maximum is ​$6,000​ for those younger than 50 and ​$7,000​ for those 50 and older. As this restriction indicates, the limit is per taxpayer, not per account.

Regardless of age, you can split your IRA contribution into two or more IRA accounts. For instance, if you're younger than 50, you might contribute $3,000 to a Roth IRA and $3,000 to a traditional IRA in 2021.

To contribute to a traditional IRA, you must have earned income from wages or other sources. What's more, your earnings must be equal to or greater than the amount of your IRA contribution(s). For instance, you are limited to a $4,000 IRA contribution if your total earned income is $4,000.

Tax-Deferred Contributions

A traditional IRA can be a great way to supercharge your nest egg by staving off taxes while you're building your savings. You get a tax break now when you put in deductible contributions.

In the future, when you take money out of the IRA, you pay taxes at your ordinary income rate. That means you can end up with hundreds of thousands of dollars more by maxing out your contributions to an IRA each year rather than putting the funds in a regular savings account.

Non-Deductible Contributions

If IRS rules prevent you from making deductible IRA contributions, you can still use your IRA account as an investment vehicle. Just make sure that your nondeductible contributions don't exceed the limits set by the IRS. For 2021, the annual limit is ​$6,000​. If you're age 50 or older, that limit is ​$7,000.

When you withdraw your nondeductible contributions from your IRA, you will have already paid taxes on those funds. The earnings on those non-deductible contributions, but not on the nondeductible contributions, are subject to tax. But the handling of the distribution of the cash from your account gets somewhat complicated at this point.

Non-Deductible Withdrawals

Rather than just removing the after-tax contributions separately as tax-free withdrawals and treating them as such, each withdrawal from a traditional IRA account is treated as a combination of nondeductible contributions, tax-deductible contributions and the earnings on both.

For instance, assume you have a $500,000 traditional IRA that includes nondeductible contributions in the amount of $50,000, which equals 10 percent of the account's balance. Also, assume you want to withdraw $10,000. In this case, 10 percent of your IRA balance, or $50,000, consists of nondeductible contributions. Consequently, 10 percent of the $10,000 withdrawal, or $1,000, is a tax-free withdrawal. You must pay tax on the remaining $9,000.

As the example illustrates, the calculation is withdrawal-specific, meaning the ratio can change with each withdrawal. So, you calculate the figure with each account withdrawal.