Tax season is here and you can still contribute for 2021, but you may be wondering where to pay your dues. When it comes to IRAs, you have two main types to choose from – Roth and traditional. Making that choice – and knowing when and how much you can contribute – isn’t always clear, so we wanted to provide some context around one of our most frequently searched topics. Here is more information on the 2 retirement options:
Roth IRA and Traditional IRA.
A traditional IRA allows you to make tax-deferred contributions. A Roth IRA holds after-tax funds that can be withdrawn tax-free. They look fundamentally different, but both accounts are designed to help you save for retirement. They also have other similarities:
1. Age limit
In the past, you couldn’t contribute to a Traditional IRA after age 70.5. However, with the passage of the Secure Every Community Retirement Improvement (SECURE) Act of 2019, you can now contribute to Roth IRAs and traditional IRAs regardless of your age. The SECURE Act made it easier for investors to save for retirement by raising the required minimum distribution age (RMD) from 70½ to 72 and removing the age limit for contributing to a traditional IRA. 2. Contribution limit
For the 2021 and 2022 tax years, you can contribute up to $6,000 if you are under age 50 and up to $7,000 if you are age 50 or older (under the catch-up provisions of the IRA). These limits apply to your total contributions to all IRAs – Roth and Traditional IRAs. These are totals for both accounts; you cannot contribute the maximum amount to each account separately. Depending on your income, your contribution limit may be lower.
3. Submission deadline
Whether you’re contributing to a traditional or Roth account, the donation deadline is the same for both accounts (this year’s deadline is April 18).
Unlike employer-sponsored retirement plans like a 401(k), you can’t take out loans from a traditional IRA or Roth. However, if you are transferring funds to the same (or similarly registered) IRA account, you can withdraw funds from your account within 60 days. You can use this rollover option every 365 consecutive days. understand the difference
To better understand the difference between a Roth and a traditional IRA, let’s focus on 3 areas:
Deductions, taxes and withdrawals.
With a traditional IRA, you can deduct your contributions (although if you or your spouse participate in an employer’s retirement plan, the deductible amount may be reduced or eliminated). When withdrawals are initiated, your deductible contributions and income will be taxed as ordinary income. If you are not eligible for deductible contributions, you can make non-deductible contributions; the non-deductible portion will not be taxed upon withdrawal. Withdrawal works as follows:
If you withdraw from a traditional IRA before age 59.5, you will pay ordinary income tax on the pre-tax portion of the representative distribution, plus a 10th distribution penalty (barring exceptions). If you withdraw after reaching 59½, you will not be penalized, but you will still pay ordinary income tax on the amount representing the pre-tax portion of the distribution.
When you turn 72 (or when you turn 70½, if you were 70½ before 2020), you’ll need to start making withdrawals from your traditional IRA. The amount you withdraw for an RMD is calculated based on your life expectancy and your account balance at the end of the previous year.
Your contributions to a Roth IRA are not deductible. This means that withdrawals of your Roth contributions (your “base”) will always be tax-free and penalty-free. Think of it as a multi-layered cake:
When you take that first bite (or in this case, your first bite), the frosting on top is your base. Under what layer? your income. You can make tax-free withdrawals as long as you’re 59½ and have owned your Roth IRA for at least 5 years. * Roth IRAs don’t require withdrawals because your contributions are already taxed, meaning you can keep your savings for as long as you have time.
Anyone with an income (or a spouse with an income) can contribute to a traditional IRA. However, you can reduce or even eliminate the amount you can contribute to a Roth IRA based on your adjusted adjusted gross income (MAGI).
If you can’t make your maximum contribution to the Roth IRA because your MAGI is near the high end of your annual income range, you can still contribute through your Roth IRA and your traditional IRA.
Learn more about income limits
Whether you qualify for Roth, traditional or both, opening this type of account is a step towards a better retirement. Your eligibility may depend on your income – so if you’re unsure what to do, contact a tax advisor to help you make an informed decision.