A traditional IRA offers the possibility of a current year tax deduction for amounts contributed to the IRA. In order to qualify, an individual must meet certain income eligibility requirements. Otherwise, a contribution to a traditional IRA can still be made, but no tax deduction can be taken on their income taxes.
Once funds are inside of an IRA, all interest, dividends, and capital gains are tax-deferred meaning that the account owner pays no taxes on the growth of that money while it is inside of the IRA. This can be an enormous advantage.
At a future date, when money is withdrawn from a traditional IRA account, the funds will be taxed as ordinary income to the account owner. To ensure that IRA accounts are not abused as asset transfer mechanisms, an IRA account holder is mandated to withdraw a certain amount of funds each year after the year in which they turn 70 ½ years old. This mandate is known as a required minimum withdrawal.
Required minimum withdrawals, or RMDs, are calculated based upon the account holder's age and the amount of money in the account. The IRS publishes tables which delinate how to calculate these RMD requirements.
Any monies that were contributed to the IRA account without the benefit of a tax deduction are known as after-tax contributions. Taxes are not due on these amounts at withdrawal. However, all of the growth, interest, and dividends paid on such funds are taxable.
All contributions for which a tax deduction was claimed are taxable as well.
For most people, withdrawals from a traditional IRA are taxable at ordinary income rates meaning that any such monies are taxed like they were income.
Withdrawing funds from a traditional IRA account prior to the account owner turning 59 ½ years old is considered an early withdrawal. Such withdrawals are subject to ordinary income taxes and a 10% penalty.