Updated on February 2, 2021
Traditional IRAs allow individuals to make contributions with money that can be deducted on your tax return. Earnings contributed to a traditional IRA can grow tax-deferred until you withdraw them in retirement. For these reasons, we call them “tax-me-later” accounts — the money usually goes in and compounds tax-free, but tax is paid on withdrawal.
Many people find themselves in a lower tax bracket when they retire than they were in pre-retirement, so the tax-deferral means the money may be taxed at a lower rate.
Contributions to traditional IRAs are often tax-deductible, meaning if you contribute $6,000 to a traditional IRA, it could reduce the amount of your taxable income by $6,000. That means if the money you contributed to a traditional IRA already had taxes withheld from it, you may be able to deduct the contribution amount from your taxable income and potentially get the tax dollars back as a refund.
The IRS limits how much money you can contribute to an IRA on a tax-free basis each year. The contribution limit for traditional IRAs in 2020 and 2021 is $6,000 per year. People 50 and older can contribute up to $7,000 per year.
The amount of your contribution that you can deduct from your taxes, also varies. If you are covered by a 401(k) or any other employer-sponsored plan, your modified adjusted gross income (MAGI) will determine how much of your contribution you can deduct—if any.