Traditional IRAs are accounts that offer aspiring retirees the opportunity to save for the future. While they do offer some advantages, traditional IRAs tend to fall short relative to other retirement accounts, like 401(k)s and Roth IRAs.
Here are four reasons you might want to avoid a traditional IRA for your retirement savings.
1. Not always tax deductible
Traditional IRAs come with specific restrictions around how much of your contribution you can deduct -- if any -- on your current-year tax return. This usually comes down to two key factors:
- Whether you're covered by a retirement plan at work, and
- How much you earn
If you're not covered by a retirement plan at work, like a 401(k) or a 403(b), you can usually deduct your entire traditional IRA contribution, regardless of how much you make.
If you are covered by a retirement plan at work, you won't receive a full deduction for your traditional IRA contribution if you make more than $73,000 (single filers) or $116,000 (married filing jointly) in 2023.
This is all to say that the rules around traditional IRA deductibility can be complicated, and you won't necessarily reduce your taxes by contributing, like you would with a traditional 401(k).
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2. Low contribution limits
Similar to the Roth IRA, you're only able to contribute up to $6,500 to a traditional IRA in 2023 ($7,500 if you're age 50 or over). This is a total contribution limit across all IRAs, so if you already contributed to a Roth IRA, you'll be either limited or completely blocked from adding to a traditional IRA.
This is in stark contrast to the contribution limits for 401(k)s, which are $22,500 for employees in 2023 ($30,000 if you're 50 or over). In other words, if you have access to one, 401(k)s offer over three times more tax-advantaged space than do traditional IRAs, which makes them more appealing from an account-structure standpoint.
3. No employer match
Unlike some 401(k)s, you won't receive any matching contribution for depositing money to a traditional IRA. With that said, make sure you're receiving the full amount of your employer match (if you have one) before venturing off to fund other retirement accounts. This means ensuring that your 401(k) contribution percentage is equal to or greater than your employer's match percentage.
Traditional IRAs offer no matching whatsoever; you're fully responsible for contributing to the account and investing the money. While you'll still receive tax deferral on any growth or earnings inside a traditional IRA, you won't receive any additional incentive to maintain the account like you would with an employer-sponsored plan.
4. Subject to required minimum distributions
Current law requires those over age 73 to take required minimum distributions (RMDs) from their pre-tax retirement accounts. This means that if you're over the RMD starting age, you'll be responsible for taking out a certain percentage of your retirement money and paying ordinary income tax on it. RMDs can have the unpleasant effect of increasing your taxable income in retirement, which can push you into a higher tax bracket or disqualify you from certain federal benefits (like paying lower Medicare premiums).
Even if your traditional IRA contributions weren't deductible at the time you made them, any accumulated growth and earnings in your traditional IRA will be taxable when you withdraw them. In other words, unless you have unrealized losses in your traditional IRA, a portion of your account will always be taxable. This is especially important to remember for broad tax-planning purposes.
Conversely, Roth IRAs don't have RMDs -- a clear and valuable benefit for those entering or in retirement.
Consider your 401(k) or a Roth IRA first
In a perfect world, you'd be able to maximize your employer-sponsored plan and an IRA of your choosing every year until you retire. Because retirement saving often involves trade-offs, it's usually a smart idea to focus on your 401(k) up to the match and a Roth IRA before thinking about a traditional IRA. Before making any sort of retirement contribution, be sure to understand the mechanics of each account and the particulars of your financial circumstances. If you're unsure, seek the help of a qualified fiduciary.
