Can the Standard Deduction still apply to a Traditional IRA early withdrawal?
"IRA distributions are reported on line 15b on the standard form 1040.  That is in the same Income section as most of your other income (including that 1099 income and W2 income, etc.).  Its income is included in the Line 22 ""Total Income"", from which the Personal Exemption (calculated on 6d, subtracted from the total in line 42) and the Standard Deduction (line 40 - also Itemized Deduction total would be here) are later reduced to arrive at Line 43, ""Taxable Income"". As such, yes, he might owe only the 10% penalty (which is reported on line 59, and you do not reduce this by the deductions, as you surmised)."
I respectfully disagree with Eric.  If you invest from day one in a Roth, where, exactly will taxable income come from to put you in a higher bracket at retirement? I agree, maybe for other reasons than you list, that early on, post-tax is the way to go, because I'll assume that one starts work in a lower bracket. There's probably a majority who start work in the 15% bracket, but over time work their way to 25%. As they grow to 25%, using the pretax 401(k) and IRA can keep them at 15% for some number of years. In any year of low income, for whatever reason, they can convert the pretax money to Roth to top off the 15% bracket.  To bring the point home, if you went post tax the whole way, imagine retiring with $2M in the Roth, but no pretax money. You now have a standard deduction, exemption, and the full 10% bracket each and every year gone to waste. Money you paid 25% tax when you could be paying zero on some of it. The deduction and exemption add to $9750 in 2012, and the 10% rate applies to the first $8700 of taxable income. If you do the math, this is $17,500, and if you plan a 4% withdrawal rate, you'd need 437,500 pretax money to give you the 17500 each year. Last, all three factors (standard deduction, exemption, and bracket limits) all rise a bit each year. An increase of $200 is another $5000 to save pretax.  Edit - 2013 brought the ability to convert within one's 401(k) from the traditional pretax side to the Roth side. This makes possible turning 100% of one's 401(k) money to Roth, and retiring without the benefite of the standard deduction, exemptions, etc. "What you're describing is a non-deductible traditional IRA.  That is what happens when your employer 401K or your high income disqualifies gou from using a traditional IRA the normal way.   Yes, non-deductible traditional IRAs are stupid.**   Now let's be clear on the mechanism behind the difference.  There's an axiom of tax law that the same money can't be taxed twice.  This is baked so deep into tax law that it often isn't even specified particularly.  The IRS is not allowed to impose tax on money already taxed, i.e. The original contribution on an ND Trad IRA.  So this is not a new kind of IRA, it is simply a Trad IRA with an asterisk.  **But then, some say so are deductible traditional IRAs when compared to the Roth.   The real power of an ND Trad IRA is that it can be converted to Roth at all income levels.  This is called the ""Roth Backdoor"".  It combines three factors. Contribute to an ND Trad IRA, stick it in a money market/sweep fund, and a week later convert to Roth, pay taxes on the 17 cents of growth in the sweep fund since the rest was already taxed.  The net effect is to work the same as a Roth contribution - not tax deductible, becomes a Roth, and is not taxed on distribution.   If you already have traditional IRA money that you contributed that wasn't taxed, this really screws things up.  Because you can't segment or LIFO your IRA money, the IRS considers it one huge bucket, and requires you draw in proportion. EEK! Suppose you contribute $5000 to an IRA in a non-deductible mode.  But you also have a different IRA funded with pretax money that now has $45,000.   As far as IRS is concerned, you have one $50,000 IRA and only $5000 (10%) is post-tax.   You convert $5000 to Roth and IRS says 90% of that money is taxable, since it's the same pool of money.  You owe taxes on all of it less the $500 fraction that was pre-taxed, and $4500 of already-taxed IRA remains in the account.  The math gets totally out-of-hand after just a couple of conversions.   Your best bet is to convert the whole shebang at one time -- and to avoid a monstrous tax hit, do this in a gap year." You're misunderstanding the concept of retirement savings. IRA distributions are taxed, in their entirety, as ordinary income. If you withdraw before the retirement age, additional 10% penalty is added. Investment income has preferential treatment - long term capital gains and qualified dividends are taxed at lower rates than ordinary income. However, IRA contributions are tax deductible. I.e.: you don't pay taxes on the amounts contributed to the IRA when you earned the money, only when you withdraw. In the mean time, the money is growing, tax free, based on your investments. Anything inside the IRA is tax free, including dividends, distributions (from funds to your IRA, not from IRA to you), capital gains, etc. This is very powerful, when taking into account the compounding effect of reinvesting your dividends/sale proceeds without taking a chunk out for taxes. Consider you make an investment in a fund that appreciated 100% in half a year. You cash out to reinvest in something less volatile to lock the gains. In a regular account - you pay taxes when you sell, based on your brackets. In the IRA you reinvest all of your sale proceeds. That would be ~25-35% more of the gains to reinvest and continue working for you! However, if you decide to withdraw - you pay ordinary rate taxes on the whole amount. If you would invest in a single fund for 30 years in a regular account - you'd pay 20% capital gains tax (on the appreciation, not the dividends). In the IRA, if you invest in the same fund for the same period - you'll pay your ordinary income rates. However, the benefit of reinvesting dividends tax-free softens the blow somewhat, but that's much harder to quantify. Bottom line: if you want to plan for retirement - plan for retirment. Otherwise - IRA is not an investment vehicle. Also consider Roth IRA/conversions. Roth IRA has the benefit of tax free distributions at retirement. If your current tax bracket is at 20%, for example, contributing $5K to Roth IRA instead of a traditional will cost you $1K of taxes now, but will save you all the taxes during the retirement (for the distributions from the Roth IRA). It may be very much worth your while, especially if you can contribute directly to Roth IRA (there are some income limitations and phaseouts). You can withdraw contributions (but not earnings) from Roth IRA - something you cannot do with a traditional IRA. According to Publication 590, broker's commissions for stock transactions within an IRA cannot be paid in addition to the IRA contribution(s), but they are deductible as part of the contribution, or add to the basis if you are making a nondeductible contribution to a Traditional IRA. (Top of Page 10, and Page 12, column 1, in the 2012 edition of Pub 590). On the other hand, trustees'  administrative fees can be paid from outside the IRA if they are billed separately, and are even deductible as a Miscellaneous Deduction on Schedule A of your income tax return (subject to the 2% of AGI threshold).  A long time ago, when my IRA account balances were much smaller, I used to get a bill from my IRA custodian for a $20 annual administrative fee which I paid separately (but never got to deduct due to the 2% threshold). My custodian also allowed  the option of doing nothing in which case the $20 would be collected from (and thus reduce) the amount of money in my IRA.  Note that this does not apply to the expenses charged by the mutual funds that you might have in your IRA; these expenses are treated the same as brokerage commissions and must be paid from within the IRA. "Click on the ? icon next to ""Employer Plan"". This is used to determine if you can deduct your annual contributions from your taxes. For more information on how an employer plan can affect your IRA tax deduction, see the definition for non-deductible contributions. So, we look there: The total of your Traditional IRA contributions that were deposited without a tax deduction. Traditional IRA contributions are normally tax deductible. However, if you have an employer-sponsored retirement plan, such as a 401(k), your tax deduction may be limited.  The $20K difference between $272K and $252K just happens to be $15% of $132,500 which is the amount of your non-deductible contributions." "What you should do is called ""re-characterization"". See the instructions for form 8606 for details (that is also the form to use to report the incident). See example 3: You made a contribution to a Roth IRA and later recharacterized part   or all of it to a traditional IRA. Report the nondeductible   traditional IRA portion, if any, on Form 8606, Part I. If you did not   recharacterize the entire contribution, do not report the remaining   Roth IRA portion of the contribution on Form 8606. Attach a statement   to your return explaining the recharacterization. If the   recharacterization occurred in 2012, include the amount transferred   from the Roth IRA on Form 1040, line 15a; Form 1040A, line 11a; or   Form 1040NR, line 16a. If the recharacterization occurred in 2013,   report the amount transferred only in the attached statement, and not   on your 2012 or 2013 tax return. You re-characterize it back to traditional IRA contribution, which will not be deductible. You then convert it back to a Roth IRA. Basically you end up at exactly the same place, except that if you already had some gains on that amount - you'll have to pay tax on them now (for the conversion, since because of the re-characterization, it will now be gains in a traditional IRA). You should of course contact your broker to do the re characterization (reassigning of the amount and its gains from a Roth IRA account to a traditional IRA account)." If for any tax year, you were eligible to make deductible contributions to a Traditional IRA, and did make the contributions in timely fashion, then there is no need to file Form 8606 for that year. Form 8606 (which tracks your basis in the IRA) is needed if Form 8606 is also needed if "So you are paying taxes on your contributions regardless, the timing   is just different. I am failing to see why would a person get an IRA, instead of just   putting the same amount of money into a mutual fund (like Vanguard) or   something like that. What am I missing? You are failing to consider the time value of money. Getting $1 now is more valuable to you than a promise to get $1 in a year, even though the nominal amount is the same. With a certain amount of principal now, you can invest it and it will (likely) grow into a bigger amount of money (principal + earnings) at a later time, and we can consider the two to have approximately equivalent value (the principal now has the same value as the principal + earnings later). With pre-tax money in Traditional IRA, the principal + earnings are taxed once at the time of withdrawal. Assuming the same flat rate of tax at contribution and withdrawal, this is equivalent to Roth IRA, where the principal is taxed at the time of contribution, because the principal now has the same value as the principal + earnings later, so the same rate of tax on the two have the same value of tax, even though when you look at nominal amounts, it might seem you are paying a lot less tax with Roth IRA (since the earnings are never ""taxed""). With actual numbers, if we take a $1000 pre-tax contribution to Traditional IRA, it grows at 5% for 10 years, and a 25% flat rate tax, we are left with $1000 * 1.05^10 * 0.75 = $1221.67. With the same $1000 pre-tax contribution (so after 25% tax it's a $750 after-tax contribution) to a Roth IRA, growing at the same 5% for 10 years, and no tax at withdrawal, we are left with $1000 * 0.75 * 1.05^10 = $1221.67. You can see they are equivalent even though the nominal amount of tax is different (the lower amount of tax paid now is equivalent to the bigger amount of tax later). With a taxable investment which you will not buy and sell until you take it out, you contribute with after-tax money, and when you take it out, the ""earnings"" portion is subject to capital-gains tax. But remember that the principal + earnings later is equivalent to the principal now, which is already all taxed once, and if we tax the ""earnings"" portion later, that is effectively taxing a portion of the money again. Another way to look at it is the contribution is just like the Roth IRA, but the withdrawal is worse because you have to pay capital-gains tax instead of no tax. You can take the same numbers as for the Roth IRA, $1000 * 0.75 * 1.05^10 = $1221.67, but where the $1221.67 - $750 = $471.67 is ""earnings"" and is taxed again at, say, a 15% capital-gains rate, so you lose another $70.75 in tax and are left with $1150.92. You would need a capital-gains tax rate of 0% to match the advantage of the pre-tax Traditional IRA or Roth IRA. After-tax money in Traditional IRA has a similar problem -- the contribution is after tax, but after it grows into principal + earnings, the ""earnings"" part is taxed again, except it is worse than the capital-gains case because it is taxed as regular income. Like above, you can take the same numbers as for the Roth IRA, $1000 * 0.75 * 1.05^10 = $1221.67, but where the $471.67 ""earnings"" is taxed again at 25%, so you lose another $117.92 in tax and are left with $1103.75. So although the nominal amount of tax paid is the same as for pre-tax money in Traditional IRA, it ends up being a lot worse. (Everything I said above about pre-tax money in Traditional IRA, after-tax money in Traditional IRA, and Roth IRA, also applies to pre-tax money in Traditional 401(k), after-tax money in Traditional 401(k), and Roth 401(k), respectively.) Regarding the question you raise in the title of your question, why someone would get contribute to a Traditional IRA if they already have a 401(k), the answer is, mostly, they wouldn't. First, note that if you merely have a 401(k) account but neither you nor your employer contributes to it during the year, then that doesn't prevent you from deducting Traditional IRA contributions for that year, so basically you can contribute to one or the other; so if you only want to contribute below the IRA contribution limit, and don't need the bigger 401(k) contribution limit, and the IRA's investment options are more attractive to you than your 401(k)'s, then it might make sense for you to contribute to only Traditional IRA. If you or your employer is already contributing to your 401(k) during the year, then you cannot deduct your Traditional IRA contributions unless your income is very low, and if your income is really that low, you are in such a low tax bracket that Roth IRA may be more advantageous for you. If you make a Traditional IRA contribution but cannot deduct it, it is a non-deductible Traditional IRA contribution, i.e. it becomes after-tax money in a Traditional IRA, which as I showed in the section above has much worse tax situation in the long run because its earnings are pre-tax and thus taxed again. However, there is one good use for non-deductible Traditional IRA contributions, and that is as one step in a ""backdoor Roth IRA contribution"". Basically, there is an income limit for being able to make Roth IRA contributions, but there is no income limit for being able to make Traditional IRA contributions or for being able to convert money from Traditional IRA to Roth IRA. So what you can do is make a (non-deductible) Traditional IRA contribution, and then immediately convert it to Roth IRA, and if you did not previously have any pre-tax money in Traditional IRAs, this achieves the same as a regular Roth IRA contribution, with the same tax treatment, but you can do it at any income level."