The Traditional IRA

• What Is a Traditional IRA?
• Traditional IRA Contribution Limits
• Traditional IRA Catch-up Contributions
• Traditional IRA Eligibility
• Traditional IRA Rules

What Is a Traditional IRA?

Created in 1974, the Traditional IRA is a tax-deferred account in which contributions are made with pre-tax dollars subject to certain conditions pertaining to active participation in a qualified plan and provided certain contribution limits are not exceeded. This allows the money contributed to the Traditional IRA to compound tax-free until funds are withdrawn. All earnings in a Traditional IRA are tax-deferred until withdrawn by the IRA owner or his/her beneficiary (unless subject to unrelated business income tax or the prohibited transaction rules are violated).

Anyone who is under the age of 70½ and has compensation* is eligible to make a contribution to a Traditional IRA.

* Compensation is defined as the wages, salaries, commissions, bonus, alimony and any other amount that you receive for providing personal services. For individuals who are self-employed, sole proprietors and partners in a a partnership, "earned income" is another term for compensation. Passive income such as interest, dividends and most rental income are not considered compensation for the purpose of funding an IRA.

Traditional IRA Contribution Limits

The contribution limit for Traditional IRAs is $5,000 in 2009 and 2010 ($6,000 if you're age 50 or older). See a full list of contribution limits for all Equity Trust IRAs and retirement plans.

Traditional IRA Catch-up Contributions

If you're age 50 or older in 2009 or 2010, you can contribute up to $6,000. See a full list of contribution limits for all Equity Trust IRAs and retirement plans.

Traditional IRA Eligibility

You can set up and make contributions to a Traditional IRA if you meet BOTH of these requirements:

• You (or, if you file a joint return, your spouse) received taxable compensation* during the year
• You were not age 70½ by the end of the year

If both spouses have compensation - If both you and your spouse have compensation and are under age 70½, each of you can set up an IRA. You cannot both participate in the same IRA.

You can have a Traditional IRA whether or not you are covered by any other retirement plan. For 2010, if you're covered by a retirement plan at work, your deduction for contributions to a Traditional IRA is reduced (phased out) if your modified adjusted gross income (AGI) is ONE of the following:

• More than $89,000 but less than $109,000 for a married couple filing a joint return or for a qualifying widow(er)
• More than $56,000 but less than $63,000 for a single individual or head of household
• Less than $10,000 for a married individual filing a separate return

For 2010, if you either live with your spouse or file a joint return— and your spouse is covered by a retirement plan at work, but you are not—your deduction is phased out if your AGI is more than $167,000 but less than $177,000. If your AGI is $177,000 or more, you cannot take a deduction for contributions to a Traditional IRA.

Traditional IRA Rules

Guidance regarding the rules and restrictions imposed upon IRAs can be found in IRS Publication 590.

If you don't follow the rules set forth for Traditional IRAs, the tax-deferred status of your account could be questioned. This could lead to disqualification of the IRA and severe tax consequences.

Prohibited transactions and prohibited investments in a Traditional IRA are clearly defined rules by the IRS.

Prohibited Transactions

Generally, a prohibited transaction is any improper use of your Traditional IRA or annuity by you, your beneficiary, or any disqualified person.

Disqualified persons include your fiduciary and members of your family (spouse, ancestor, lineal descendant, and any spouse of a lineal descendant).

The following are examples of prohibited transactions with a Traditional IRA:

• Borrowing money from it
• Selling property to it
• Receiving unreasonable compensation for managing it
• Using it as security for a loan
• Buying property for personal use (present or future) with IRA funds

Fiduciary - For IRA purposes, a fiduciary is someone who does any of the following:

• Exercises any discretionary authority or discretionary control in managing your IRA, or exercises any authority or control in managing or disposing of your IRA's assets
• Provides investment advice to your IRA for a fee, or has any authority or responsibility to do so.
• Has any discretionary authority or discretionary responsibility in administering your IRA

Effect on an IRA - Generally, if you or your beneficiary engages in a prohibited transaction in connection with your Traditional IRA at any time during the year, the account stops being an IRA as of the first day of that year.

Effect on you or your beneficiary - If your account stops being an IRA because you or your beneficiary engaged in a prohibited transaction, the account is treated as though it distributed all of its assets to you at their fair market values on the first day of the year. If the total of those values is more than your basis in the IRA, you'll have a taxable gain that's included in your income.

Prohibited Transactions - Investment in Collectibles

If your Traditional IRA invests in collectibles, the amount invested is considered to be distributed to you in the year it was invested. You may also have to pay the 10% additional tax on early distributions.

Collectibles include:

• Artworks
• Rugs
• Antiques
• Metals
• Gems
• Stamps
• Coins
• Alcoholic beverages, and
• Certain other tangible personal property.

Exceptions

Your IRA can invest in the following:

• Gold coins of one, one-half, one-quarter, or one-tenth ounce minted by the U.S. Treasury Department
• One-ounce silver coins minted by the U.S. Treasury Department
• Certain platinum coins
• Certain gold, silver, palladium, and platinum bullion.

Age 70½ Rule  

Contributions cannot be made to your Traditional IRA for the year in which you reach age 70½ or for any year after that.

For IRA purposes, you reach 70½ on the date that's six calendar months after the 70th anniversary of your birth. For example, if you were born on June 30, 1937, the 70th anniversary of your birth is June 30, 2007—therefore you reached age 70½ on December 30, 2007. If you were born on July 1, 1937, the 70th anniversary of your birth was July 1, 2007—and you turned 70½ on January 1, 2008.

Early Distributions

You can withdraw funds from a Traditional IRA without penalty at any time after you have attained the age of 59½. If you decide to withdraw money from your Traditional IRA account prior to the attainment of age 59½ you will be subject to the imposition of a 10% early distribution penalty tax.

Are there exceptions to the 10% early distribution penalty tax?

Yes, there are several exceptions to the 10% early distribution penalty tax. Among the exceptions recognized under the Internal Revenue Code are the distributions due to the following events:

• Death
• Disability
• Higher education expense of the IRA owner, spouse and/or children
• Unreimbursed medical expenses that exceed 7.5% of your adjusted gross income
• Medical insurance premiums
• Expenses associated with buying or building a first home
• Part of a series of substantially equaly periodic paymens made for the life (or life expectancy) of the IRA owner or the joint lives (or joint life expectancy) of the IRA owner and beneficiary
• Payment of any IRS levy
• Qualified reservist distribution

For additional information regarding the exceptions to the early distribution rules, please read IRS Publication 590.