With a traditional IRA, you get a tax deduction for the savings you contribute to the account. This deduction reduces your taxable income, so you are basically not paying tax on the income you set aside in a Traditional IRA. The savings grow tax-deferred, which means you won’t have to include interest, dividends, or capital gains from the IRA in your annual income. When you withdraw the money, the distribution from the IRA is included in your taxable income. It is taxed as ordinary income. If you withdraw the money before reaching age 59 and a half, there is an additional 10% tax on that early distribution. You must begin withdrawing money from a traditional IRA beginning with the year when you turn age 70.5 years old.
There are restrictions on who can take a deduction for Traditional IRA contributions. If you or your spouse are covered by a retirement plan at work, your deduction may be limited or you might not be able to deduct any of your contribution.
Nondeductible Traditional Individual Retirement Accounts
A nondeductible IRA is a traditional IRA. However, the contributions are not tax-deductible. The savings grow tax-deferred. When you start taking distributions, part of the distribution will be a tax-free return of your original, nondeductible contribution, and the rest will be taxed as ordinary income. People usually opt for a nondeductible IRA when they are covered by a retirement plan through their employer and their income is too high to be eligible to deduct their IRA contributions and they want to contribute extra savings towards retirement. The only difference between a nondeductible IRA and a traditional IRA is the tax treatment of the original contribution.