Table Of Contents
- Both Roth and Traditional IRAs are reliable ways to save money for retirement.
- You can open an IRA even if you (or your spouse) have an employer-sponsored 401(k) or pension plan; it may affect how much you can deduct from your taxes.
- For 2023, total contributions to all IRA accounts for any individual are limited to $6,500 or the total annual taxable income, if less than $6,500.
- If you’re over 50, you can contribute an extra $1,000/year. This gives people closer to retirement a bump in savings.
- Most people try to choose an investment strategy that will result in paying the lost amount of taxes possible.
What Is An IRA And How Do They Work?
An Individual Retirement Account (IRA) is a savings account designed with tax incentives to help individuals save for retirement.
You can open an IRA through most banks or brokerage firms.
Anyone can open an IRA, but your age, income level, and employer-provided retirement plan all affect how much money you are eligible to contribute to your IRA annually.
IRAs won’t affect your Social Security benefit.
With a traditional IRA, you can deposit pre-tax dollars. That means you have more money to grow in the account. When you start taking distributions (withdrawals), they will be included in your taxable income.
There is a 10% tax (on top of your normal taxation rate) if you start taking disbursements before age 59 ½.
That means if you are currently in a high tax bracket and you think it will be lower when you start taking distributions, a traditional IRA might save you money.
With a Roth IRA, you deposit after-tax dollars, but the distributions are not taxed upon withdrawal.
So if you are currently in a relatively low tax bracket, it might be worth paying the tax now so you don’t have to later on.
Most investors try to choose the route that will result in them paying the least amount of taxes.
Table: Traditional IRA vs. Roth IRA
|Traditional IRA||Roth IRA|
|Taxed as income upon withdrawal||Not taxed upon withdrawal|
|Can claim contributions as a deduction on a Federal Tax Return||Cannot claim deductions on a Federal Tax Return|
|Additional 10% tax if withdrawn under age 59 ½||Withdrawals not taxed|
|Must begin taking withdrawals when you turn 72||Withdrawals not required until account owner’s death|
|Can take disbursements at any time; must file additional forms||Can take disbursements at any time; must file additional forms|
Anyone can open an IRA through most banks or brokerage accounts.
If you (or your spouse) have a retirement plan through your employer, you can still open either a traditional or a Roth IRA. There will be limits on how much you can contribute and how much of your contribution you can deduct on your Federal Tax Return.
Your annual taxable income and marital status affect how much you can contribute.
Contribution Limits For IRAs
The IRS sets contribution limits for IRAs.
For 2023, you can contribute a total of $6,500 to all IRAs you own, traditional and Roth.
If you are over 50 years old, you can contribute an additional $1,000 annually for a total of $7,500.
If you earned less than $6,500 in income, then your IRA contribution limit is the total amount of your taxable income. So for example, if your income was $4,000, you could deposit all of it into your IRA.
If you are married and filing taxes jointly but your income was under the $6,500 threshold, you can generally still contribute to your own IRA up to the full amount. This is called a Spousal IRA and the IRA publishes guidelines here, so you can check and see if you qualify.
Roth IRA Pros And Cons
Pros of a Roth IRA:
- Great for savers starting when they are young
- You can contribute for as long as you want
- You don’t have to start taking distributions at any particular time
- You can leave money in your account for your beneficiaries
- Distributions are not taxed upon withdrawal
Cons of a Roth IRA:
- Contributions are not tax-deductible
- Those with currently high taxation rates now may end up paying more tax on the money
Traditional IRA Pros And Cons
Pros of a Traditional IRA:
- Great for savers with a currently high taxation rate (e.g. high earners) who expect to be in a lower tax bracket upon retirement
- Contributions are tax-deductible at the time you deposit them.
Cons of a Traditional IRA:
- Additional 10% tax on distributions if you take them before age 59 ½
- Individuals with large assets may end up in a higher tax bracket than they planned upon retirement
- You must begin taking withdrawals by age 72
Frequently Asked Questions (FAQs)
Is it beneficial to have both a Roth IRA and traditional IRA account?
It depends on your financial situation. Keep in mind that you are limited to a contribution amount of $6,500 ($7,500 if you’re over 50) on all IRAs COMBINED. If you don’t know what your financial status will be decades from now, it might be smart to diversify your investments so some are pre-tax (traditional) and some are post-tax (Roth).This way, you spread out the risk just in case your tax bracket looks different than you expected upon retirement.