Personal Finance 101 – IRAs: Are You Team Traditional or Team Roth? Part One

By Brittany Mollica

You’re a saver, and you’ve heard that contributing to a Traditional or Roth IRA is a good tax move. But you may be bewildered about the difference and trying to decide which one is for you. We’re here to help! This post is part one of two and will discuss the rules of Traditional and Roth IRAs.

The basics:

  • IRA stands for Individual Retirement Account. Only you can open and own your Traditional or Roth IRA. There is no joint ownership.
  • You (or your spouse, if you’re married) must have earned income for you to be allowed to contribute to an IRA. Some examples of earned income: wages, salaries, commissions or tips.
  • There is a maximum amount that you may contribute to a Traditional or Roth IRA each year. For 2019, that maximum for either account is the lesser of your earned income or $6,000 (or $7,000 if you’re age 50+). You can also split your contribution between the Traditional IRA and Roth IRA – for example, you could contribute $2,000 to a Traditional IRA and $4,000 to a Roth IRA.
  • There are also employer-provided retirement plans (e.g. 401(k)) and inherited IRAs, which can be designated Traditional or Roth. The rules for those accounts are different and beyond the scope of this post.

Besides all that, Traditional IRAs and Roth IRAs follow a few different rules.

Taxation (the primary difference between Traditional and Roth IRAs)

Traditional IRAs:

Contributing to the account may lower your tax bill for the year, as you usually benefit from a tax deduction for the amount you put in. Then, if all goes well, your investments grow. When you retire, the money you take out of the account is taxed as income.

Roth IRAs:

You contribute to the account but cannot take any deductions for this year. Again, you hope your investments grow. And the fun part of a Roth is when you take qualified distributions out during retirement – the whole distribution is tax free!

 

Age Limitations

Traditional IRAs:

Once you turn 70½, you can no longer contribute to a Traditional IRA. In fact, at that age, you are required to start taking money OUT of the account as a taxable distribution.

Roth IRAs:

No age limitations – you may contribute to a Roth IRA at any age, pending income limits. You are never required to take money out of a Roth IRA during your lifetime.

 

Income Limitations

Traditional IRAs:

The basic rule is that, as long as you or your spouse have earned income, you may always contribute to a Traditional IRA until age 70 ½. However, you may or may not be allowed to deduct that contribution on your tax return. The numbers below refer to your Modified Adjusted Gross Income (see a tax advisor if you need help determining your MAGI).

  • If you are single: once your MAGI exceeds $64,000 (for 2019), you will NOT be allowed to deduct the full contribution.
    • One important exception – if your employer does not offer a company retirement plan, you are always allowed to deduct your contribution, regardless of your income.
  • If you are married: once your joint MAGI exceeds $103,000 (for 2019), you will NOT be allowed to deduct the full contribution.
    • Again, the exception – if neither you NOR your spouse have employer retirement plans, you may deduct your contribution regardless of income level.
    • But what if your spouse has an employer retirement plan and you don’t? Then you may deduct your full contribution as long as your joint MAGI is less than $193,000 (for 2019).

If you are above the income limit, you won’t be able to deduct your contribution from your taxes but you will still be allowed to contribute. If this is the case for you, we recommend you speak with a tax professional before making any contributions.

Roth IRAs:

The rules are a bit simpler for Roth IRAs. Since contributions are not deductible for a Roth, your income level simply determines whether or not you are allowed to make a contribution.

  • If you are single and MAGI exceeds than $122,000 (for 2019), you may NOT make a full contribution to a Roth. If MAGI is between $122,000 and $137,000, you may be able to make a partial contribution.
  • If you are married and MAGI exceeds $193,000 (for 2019), you are NOT allowed to make a full contribution. If MAGI is between $193,000 and $203,000, you may be able to make a partial contribution.

In summary, keeping up with all the IRA rules can be exhausting (the contribution and eligibility limits often change yearly!). That’s one reason why it’s helpful to have a financial advisor. Stay tuned for Part Two that will discuss whether you should choose Team Traditional or Team Roth.

 

This material is provided as a courtesy and for educational purposes only.  Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation. 

Hilltop Wealth Advisors does not provide tax advice.  The tax information contained herein is general and is not exhaustive by nature.  Federal and state laws are complex and constantly changing.  You should always consult your own legal or tax professional for information concerning your individual situation.