Both traditional and Roth IRAs feature tax-sheltered
growth of earnings. And both
give you a wide range of investment
choices. However, there are important
differences between these two types of
IRAs. You must understand these
differences before you can choose the type
of IRA that's best for you. Even if you're contributing to a
401(k) or other plan at work, you might
also consider investing in an IRA. IRAs
are one of the most powerful retirement
savings tools available to you. *Your beneficiary must take distributions following your death.
In general, you can make only one tax-free, 60-day (indirect)
rollover from any IRA (Roth or traditional) you own to any other
IRA you own (or back to the same IRA), in any one year period, no matter how many IRAs you own. This limit does not apply
to direct (trustee-to-trustee) transfers or to Roth conversions. | |
Understanding IRAs
An individual retirement arrangement (IRA) is a personal
savings plan that offers specific tax benefits.
IRAs are one of the most powerful retirement savings
tools available to you. Even if you're contributing
to a 401(k) or other plan at work, you may want to
consider investing in an IRA.
What types of IRAs are available?
The two major types of IRAs are traditional IRAs and
Roth IRAs. Both allow you to contribute as much as
$7,000 in 2024 (up from $6,500 in 2023), but you must have at least as
much taxable compensation as the amount of your
IRA contribution. If you are married filing jointly,
your spouse can also contribute to an IRA, even if
he or she does not have taxable compensation. The
law also allows taxpayers age 50 and older to make
additional "catch-up" contributions. These folks
can
contribute an additional $1,000 in 2024 (unchanged from 2023).
Both traditional and Roth IRAs feature tax-sheltered
growth of earnings. And both give you a wide range
of investment choices. However, there are important
differences between these two types of IRAs. Understanding these differences is key to
choosing the type of IRA that may be appropriate for you. Note:
Special rules apply to certain
reservists and national guardsmen called to active
duty after September 11, 2001.
Learn the rules for traditional IRAs
Practically anyone can open and contribute to a traditional
IRA. The only requirement is that you
must have taxable compensation. You can contribute the maximum allowed each
year as long as your taxable compensation for the
year is at least that amount. If your taxable compensation
for the year is below the maximum contribution
allowed, you can contribute only up to the
amount that you earned.
Your contributions to a traditional IRA may be tax
deductible on your federal income tax return. This is
important because tax-deductible (pre-tax) contributions
lower your taxable income
for the year, saving
you money in taxes. If neither
you nor your spouse is
covered by a 401(k) or other
employer-sponsored plan,
you can generally deduct the
full amount of your annual
contribution. If one of you is
covered by such a plan, your
ability to deduct your contributions
depends on your
annual income (modified
adjusted gross income, or
MAGI) and your income tax filing status.
For 2024, if you are covered by a retirement plan at
work and:
- Your filing status is single or head of household,
and your MAGI is $77,000 or less, your traditional
IRA contribution is fully deductible. Your
deduction is reduced if your MAGI is between
$77,000 and $87,000, and you can't
deduct your contribution at all if your MAGI is
$87,000 or more.
- Your filing status is married filing jointly or qualifying
widow(er), and your MAGI is $123,000 or
less, your traditional IRA contribution is fully deductible.
Your deduction is reduced if your MAGI
is between $123,000 and $143,000,
and you can't deduct your contribution at all if
your MAGI is $143,000 or more.
- Your filing status is married filing separately, your
traditional IRA deduction is reduced if your MAGI
is less than $10,000, and you can't deduct your
contribution at all if your MAGI is $10,000 or
more.
For 2024, if you are not covered by a retirement plan
at work, but your spouse is, and you file a joint tax
return, your traditional IRA contribution is fully deductible
if your MAGI is $230,000 or less. Your deduction
is reduced if your MAGI is between
$230,000 and $240,000, and you can't deduct
your contribution at all if your MAGI is $240,000
or more.
What happens when you start taking money from
your traditional IRA? Any portion
of a distribution that represents
deductible contributions is
subject to income tax because
those contributions were not
taxed when you made them.
Any portion that represents investment
earnings is also subject
to income tax because
those earnings were not previously
taxed either. Only the
portion that represents nondeductible,
after-tax contributions (if any) is not subject
to income tax. In addition to income tax, you may
have to pay a 10% early withdrawal penalty if
you're under age 59½, unless you meet one of the
exceptions.
If you wish to defer taxes, you can leave your funds
in the traditional IRA, but only until April 1 of the year
following the year you reach age 73 (75 for those who reach age 73 after December 31, 2032). That's when
you have to take your first required minimum distribution
(RMD) from the IRA. After that, you must take a distribution
by the end of every calendar year until you
die or your funds are exhausted. The annual distribution
amounts are based on a standard life expectancy
table and your previous year-end combined account balances. You can always withdraw more than
you're required to in any year. However, if you withdraw
less, you'll be hit with a 50% penalty on
the difference between the required minimum and
the amount you actually withdraw.
Learn the rules for Roth IRAs
Not everyone can set up a Roth IRA. Even if you
can, you may not qualify to take full advantage of it.
The first requirement is that you must have taxable
compensation. If your taxable compensation in 2024
is at least $7,000, you may be able to contribute the
full amount. But it gets more complicated. Your ability
to contribute to a Roth IRA in any year depends
on your MAGI and your income tax filing status.
- If your filing status is single or head of household,
and your MAGI for 2024 is $146,000 or
less, you can make a full contribution to your
Roth IRA. Your Roth IRA contribution is reduced
if your MAGI is between $146,000 and$161,000, and you can't contribute to
a Roth IRA at all if your MAGI is $161,000 or
more.
- If your filing status is married filing jointly or
qualifying widow(er), and your MAGI for 2024 is
$230,000 or less, you can make a full contribution
to your Roth IRA. Your Roth IRA contribution
is reduced if your MAGI is between
$230,000 and $240,000, and you can't
contribute to a Roth IRA at all if your MAGI is
$240,000 or more.
- If your filing status is married filing separately,
your Roth IRA contribution is reduced if your
MAGI is less than $10,000, and you can't contribute
to a Roth IRA at all if your MAGI is $10,000
or more.
Your contributions to a Roth IRA are not tax deductible.
You can invest only after-tax dollars in a Roth
IRA. The good news is that if you meet certain conditions,
your withdrawals from a Roth IRA will be completely
income tax free, including both contributions
and investment earnings. To be eligible for these
qualifying distributions, you must meet a five-year
holding period requirement. In addition, one of the
following must apply:
- You have reached age 59½ by the time of the
withdrawal
- The withdrawal is made because of disability
- The withdrawal is made to pay first-time home buyer
expenses ($10,000 lifetime limit)
- The withdrawal is made by your beneficiary or
estate after your death
Qualified distributions will also avoid the 10%
early withdrawal penalty. This
ability to withdraw your funds
with no taxes or penalties is a
key strength of the Roth IRA.
And remember, even nonqualified
distributions will be taxed
(and possibly penalized) only
on the investment earnings
portion of the distribution, and
then only to the extent that
your distribution exceeds the
total amount of all contributions
that you have made.
Another advantage of the Roth IRA is that there are
no required distributions at any
time during your life. You can put off taking distributions
until you really need the income. Or, you can
leave the entire balance to your beneficiary without
ever taking a single distribution.*
Choose the right IRA for you
Assuming you qualify to use both, which type of IRA
is best for you? Sometimes the choice is easy. The
Roth IRA will probably be a more effective tool if you
don't qualify for tax deductible
contributions to
a traditional IRA. However,
if you can deduct your
traditional IRA contributions,
the choice is more
difficult. Most professionals
believe that a Roth IRA
will still give you more
bang for your dollars in the
long run, but it depends on
your personal goals and
circumstances. The Roth
IRA may very well make
more sense if you want to
minimize taxes during retirement and preserve assets
for your beneficiaries. But a traditional deductible
IRA may be a better tool if you want to lower
your yearly tax bill while you're still working (and
probably in a higher tax bracket than you'll be in
after you retire). A financial professional or tax advisor
can help you pick the right type of IRA for you.
Note:
You can have both a traditional IRA and a
Roth IRA, but your total annual contribution to all of
the IRAs that you own cannot be more than $7,000
in 2024 ($8,000 if you're age 50 or older).
Know your options for transferring your funds
You can move funds from an IRA to the same type of
IRA with a different institution (e.g., traditional to traditional,
Roth to Roth). No taxes or penalty will be
imposed if you arrange for the old IRA trustee to
transfer your funds directly to the new IRA trustee.
The other option is to have your funds distributed to
you first and then roll them over to the new IRA trustee
yourself. You'll still avoid taxes and penalty as
long as you complete the rollover within 60 days from
the date you receive the funds.
You may also be able to convert funds from a traditional
IRA to a Roth IRA. This decision is complicated,
however, so be sure to consult a tax advisor.
He or she can help you weigh the benefits of shifting
funds against the tax consequences and other drawbacks.
Note:
The IRS has the authority to waive the 60-day
rule for rollovers under certain limited circumstances,
such as proven hardship. |