What is a Traditional IRA?

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Traditional IRA

Established in 1974, the individual retirement account (IRA) has become a retirement savings cornerstone for many working Americans. Not only do IRAs offer a convenient tool for building wealth, they also provide certain tax advantages that may benefit taxpayers both now and in the future.

IRAs Defined

An IRA is a vehicle that allows taxpayers to save for retirement while potentially saving on income taxes. Within the account, individuals can choose to invest in a variety of investment types, from certificates of deposit (CDs), mutual funds, or individual stocks and bonds.

The most common choices of IRAs are traditional and Roth. This article will focus on the traditional IRA. Taxpayers wanting to learn more about the Roth IRA might want to read our Roth IRA article and speak with a tax advisor.

Tax Advantages

IRAs offer two primary tax benefits. First, contributions may be tax deductible – an advantage that investors realize almost immediately (or at least at tax time – see To Deduct or Not to Deduct? below). Second, IRAs allow investors to shelter earnings from taxes each year and reinvest them to pursue future growth, in a process known as tax-deferred compounding.

By contrast, taxable accounts such as regular brokerage accounts and passbook savings accounts require taxpayers to pay income taxes each year on realized and/or reinvested earnings. IRA owners do have to pay current taxes on the earnings but taxes will be due when withdrawals are made. These withdrawals often take place during retirement when many taxpayers may be in a lower tax bracket.

IRA Contribution Limits

Individuals under age 70 1/2 can open an IRA for the current tax year anytime and may make a contribution before the due date for filing income tax returns for that year (in most years, April 15 of the following year). For 2015, IRA contributions are limited to $5,500 in earned income for those under age 50; $6,500 for age 50 and up. Married couples who file their income tax returns jointly can double those amounts as long as the total is divided equally between two individual IRAs and doesn’t exceed the couple’s taxable annual compensation.

Married couples with only one wage earner may open a spousal IRA in the non-earner’s name and contribute up to the full individual limits.

To Deduct or Not to Deduct?

Tax deductibility of contributions depends on two factors: whether the account holder is covered by a retirement plan at work and the individual’s or couples’ adjusted gross income (AGI).

Taxpayers who are covered by a retirement plan at work can generally deduct all of their IRA contributions. Individuals who are covered by a work-based plan may be able to take a full or partial deduction, depending on their AGI. For 2015, deductibility phases out between $61,000 and $71,000 for single individuals or heads of houseld and $98,000 and $118,000 for married couples filing jointly. For spousal IRA situations in which the wage-earning spouse is covered by a retirement plan, phase out occurs between $183,000 and $193,000. (Married couples filing separately have very limited deductibility options.)

The Role of Rollovers

IRAs can become especially useful for many employees when leaving an employer. The reason? Employees who have assets in an employer-sponsored plan are typically permitted to take any vested amounts with them. Vested assets are those that belong to the plan participant with no restraints or conditions on withdrawal. However, cashing out can result in a substantial tax and penalty burden. An IRA rollover, on the other hand, allows taxpayers to maintain control of the money while maintaining tax deferral.

Withdrawal Words of Wisdom

Because IRAs were designed specifically to help Americans prepare for the time when the regular paychecks stop, the tax code discourages withdrawals prior to retirement age. Distributions taken before the account holder reaches 59 ½ are subject to a 10% penalty tax (in addition to regular income taxes), with the following exceptions:

  • Disability or death of the account holder
  • First-time home purchase ($10,000 limit)
  • Higher education expenses
  • Un-reimbursed medical expenses that exceed 7.5% of adjust gross income
  • Medical insurance premiums, after loss of your job
  • Equal periodic payments spread over life or life expectancy
  • Qualified reservist distributions

Early withdrawals should be considered carefully. In addition to the taxes incurred, these withdrawals, if not reinvested in a tax qualified vehicle, will impact the amount of savings an investor is able to accumulate over time to support lifestyle choices in retirement.

In addition, the IRS doesn’t permit IRA owners to avoid taxation entirely. For this reason, minimum distributions must begin by April 1 following the year in which an individual reaches age 70½. Failure to withdraw the required amount each year may result in an excise tax equal to 50% of the required amount.

By signing the Employee Retirement Income Security Act of 1974, President Ford provided Americans with several potentially golden opportunities to build wealth for the future. One of them – the IRA -- can play a key role in almost any investor’s financial strategy.

If an IRA rollover is right for you, this website can help you understand and explore your options, as well as learn more about the next steps in the process.

About John Hancock

John Hancock is a unit of Manulife Financial Corporation, a leading Canadian-based financial services group serving millions of customers in 22 countries and territories worldwide. Operating as Manulife Financial in Canada and Asia, and primarily through John Hancock in the United States, the Company offers clients a diverse range of financial protection products and wealth management services through its extensive network of employees, agents and distribution partners. Funds under management by Manulife Financial and its subsidiaries were $596 billion as of December 31, 2014. Manulife Financial Corporation trades as 'MFC' on the TSX, NYSE and PSE, and under '0945' on the SEHK. Manulife Financial can be found on the Internet at www.manulife.com. John Hancock may be found on the Internet at www.johnhancock.com.

The John Hancock unit, through its insurance companies, comprises one of the largest life insurers in the United States. John Hancock offers a broad range of financial products and services, including whole life, term life, variable life, and universal life insurance, as well as college savings products, fixed and variable annuities, long-term care insurance, mutual funds and various forms of business insurance.

A fund’s investment objectives, risk, charges and expenses should be considered carefully before investing. The prospectus includes this and other important information about the fund. To obtain a prospectus, call your financial professional, John Hancock Investments at 1-800-255-5291 or visit our web site at www.jhinvestments.com. Please read the prospectus carefully before investing or sending money.

This material does not constitute tax, legal or accounting advice and neither John Hancock nor any of its agents, employees or registered representatives are in the business of offering such advice. It was not intended or written for use and cannot be used by any taxpayer for the purpose of avoiding any IRS penalty. It was written to support the marketing of the transactions or topics it addresses. Anyone interested in these transactions or topics should seek advice based on his or her particular circumstances from independent professional advisors.

John Hancock Funds, LLC
Member FINRA
601 Congress Street
Boston, MA 02210-2805
www.jhinvesments.com



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Mutual Funds
Privately Managed Accounts
Retirement Plans
NOT FDIC INSURED, MAY LOSE VALUE,
NO BANK GUARANTEE. NOT INSURED BY
ANY GOVERNMENT AGENCY.

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