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Opening an individual retirement account (IRA) can be a great way to save on taxes while investing in your future and setting yourself up for a successful retirement. IRAs are the second most popular type of retirement account in the U.S., behind employer-sponsored retirement accounts, such as the 401(k) and 403(b).
Every year, the IRS releases its contribution limits for IRAs. In 2023, the maximum amount you can contribute to all of your traditional IRAs and Roth IRAs combined was $6,500. You can contribute up to a total of $7,500 with $1,000 in catch-up contributions if you are age 50 or older. For 2024, the contribution limit rises to $7,000, with the catch-up contribution staying the same.
Additionally, your contributions cannot exceed your taxable compensation for the year, if it is less than these limits. However, if youโre married filing jointly, you can use your spouseโs taxable compensation to meet this requirement and contribute to an IRA for yourself even if you have no earnings of your own.
You can contribute to a traditional IRA if youโor your spouse, if you are married filing jointlyโhave taxable compensation.Traditional IRAs allow you to save on taxes in the present by deducting your contributions in the year in which you make them, with certain limitations for those who have (or whose spouse has) a retirement plan at work. You will, however, owe taxes on your withdrawals in the future. If you wish to avoid the additional 10% early withdrawal penalty, you will either have to wait until you are 59ยฝ or meet any one of the following criteria for a penalty-free exception.
Because you owe taxes only when you make withdrawals from your traditional IRA, the IRS has set rules for required minimum distributions (RMDs) that you must take when you reach a certain age. If you have not already, you should have started making withdrawals when you reach age 72 (or age 73 if your 72nd birthday is after Dec. 31, 2022). The first year following your 72nd birthday, you will have two required distribution dates: April 1 and December 31. You can alternatively take the first distribution before December 31 of the year you turn 72 to keep the two RMDs in separate tax years. In subsequent years, the distribution date is December 31.
Contributions to a Roth IRA are not tax deductible. Instead, your qualified distributions in retirement will be tax-free as long as you meet all the requirements for a Roth IRA. Another benefit to the Roth IRA is your ability to withdraw your contributions at any point, without being subject to tax or an early withdrawal penalty. Note: That is only for contributions you have previously made to the Roth IRA, not earnings.
Earnings cannot be withdrawn tax-free from a Roth IRA until you have passed five years from your first contribution. At that point, earnings can only be withdrawn without the 10% early withdrawal penalty if you have reached the age of 59ยฝ or have met any one of the criteria for penalty-free exceptions listed above.
You can contribute to a Roth IRA if youโor your spouse, if you are married filing jointlyโhave taxable compensation. However, Roth IRAs have additional income-based contribution limits that put further restrictions on the contribution limits for all IRAs. Based on your filing status, you can find your Roth IRA contribution limits for 2023 and 2024 according to your modified adjusted gross income (MAGI) in the following chart.
Filing status | Up to the limit | A reduced amount | Zero contributions |
---|---|---|---|
Married filing jointly or qualifying widow(er) | Less than $218,000 in 2023; less than $230,000 in 2024. | Between $218,000 and $228,000 in 2023; between $230,000 and $240,000 in 2024 | $228,000 or more in 2023; $240,000 or more in 2024 |
Married filing separately (and you lived with spouse at any time during year) | N/A | Less than $10,000 in both 2023 and 2024 | $10,000 or more in both 2023 and 2024 |
Single, head of household, or married filing separately (and you did not live with spouse) | Less than $138,000 in 2023; less than $146,000 in 2024. | Between $138,000 and $153,000 in 2023; between $146,000 and $161,000 in 2024. | $153,000 or more in 2023; $161,000 in 2024. |
Roth IRAs do not have required minimum distributions if you are the original owner of the IRA. However, after your death, your beneficiary will be required to take RMDs. The rules for beneficiaries are complicated; a good tax advisor can be helpful.
Traditional IRAs and Roth IRAs mainly differ in the timing of their tax benefits. Traditional IRAs provide a tax benefit in the present, while Roth IRAs provide a tax benefit in your retirement years. Here is a chart that compares the features of a traditional IRA with those of a Roth IRA.
Traditional IRA | Roth IRA | |
---|---|---|
Contribution limits | In 2023, $6,500 (or $7,500 for those age 50 and up). In 2024, $7,000 ($8.000 if age 50+) * applies to total of all your traditional and Roth IRAs | In 2023, $6,500 (or $7,500 for those age 50 and up). In 2024, $7,000 ($8.000 if age 50+) * applies to total of all your traditional and Roth IRAs |
Income limits | None | Based on MAGI, you may not be eligible to contribute directly to a Roth IRA. The 2023 phase-out range is $218,000 to $228,000 for taxpayers who are married filing jointly. In 2024, itโs $230,000 to $240,000 The 2023 and 2024 phase-out range is between zero and $10,000 for married taxpayers who lived together at any point in the year and are filing separately. The 2023 phase-out range is $138,000 to $153,000 for all other taxpayers. In 2024, itโs $146,000 to $161,000. |
Age limits | As of 2020, there is no age limit on contributions. Prior to 2020, it was 70ยฝ. | None |
Tax treatment | Contributions are generally tax-deductible (with some limitations), and you will owe taxes upon withdrawal. | Contributions are not tax-deductible, but withdrawals are tax-free if you meet certain criteria. |
Tax credit | The retirement savings contributions credit allows you to claim a tax credit of up to 50% of your contribution, depending on your adjusted gross income. For 2023, the credit phases out at an AGI of $73,000 for married filing jointly, $54,750 for head of household, and $36,500 for all other filers. For 2024, itโs $76,500, $57,375, and $38,250 respectively for the groups listed above. The maximum contribution amount that qualifies is $2,000 ($4,000 if you are married filing jointly), and the maximum credit is $1,000 (or $2,000 if married filing jointly). | The retirement savings contribution credit allows you to claim a tax credit up to 50% of your contribution, depending on your adjusted gross income. For 2023, the credit phases out at an AGI of $73,000 for married filing jointly, $54,750 for head of household, and $36,500 for all other filers. For 2024, itโs $76,500, $57,375, and $38,250 respectively for the groups listed above. The maximum contribution amount that qualifies is $2,000 ($4,000 if you are married filing jointly), and the maximum credit is $1,000 (or $2,000 if married filing jointly). |
Withdrawal rules | Upon withdrawal, you will owe taxes. If you are under age 59ยฝ, you will have an additional 10% early withdrawal penalty, unless you qualify for an exception. | Contributions can be withdrawn at any time, for any reason, tax-free and penalty-free. Earnings can be withdrawn tax-free if you have waited at least five years from your first contribution. If you are under age 59ยฝ, you will have a 10% early withdrawal penalty on distributions of earnings, unless you qualify for an exception. |
Required minimum distributions | Required as of age 72 (or age 73 if your 72nd birthday is after December 31, 2022) | Not required for original owner |
Earnings rate | Because contributions are tax-deferred, traditional IRAs have a higher rate of return when you consider the same initial pre-tax income investment. | Because contributions are made with after-tax money, Roth IRAs have a lower rate of return when you consider the same initial pre-tax income investment. |
Both the traditional IRA and Roth IRA allow you to save for retirement in a tax-advantaged way. Both types of IRAs have the same maximum contribution limit of $6,500 in 2023 ($7,500 for those age 50 and over) and $7,000 in 2024 ($8,000 for those age 50 and over). However, the Roth IRA may be limited even further based on your MAGI. Both have potential early withdrawal penalties of 10% if you withdraw funds improperly before the age of 59ยฝ. For Roth IRAs, this is only an issue for withdrawals that are not considered qualified distributions.
The Roth IRA provides the freedom of tax-free withdrawals in retirement. If you prefer to have the luxury of keeping all the money you withdraw from your retirement account while youโre enjoying your retirement, a Roth IRA may be best for you.
The traditional IRA provides the benefit of a tax deduction in the year in which you make a contribution. It allows you to lower your taxable income by contributing a portion of your income into your retirement account. The time value of money states that the same amount of money in the present is worth more than the theoretical same amount of money in the future.
If you place a high importance on the time value of money, you may prefer a traditional IRA. Of course, there are other factors to consider that may affect your decision to pay taxes now or in retirement, including the impact of inflation, potential tax rate changes between now and your retirement, and your current and future potential income at the age when you are taking RMDs.
Some high-income taxpayers do not qualify to contribute directly to a Roth IRA due to the income-based contribution limits. A backdoor Roth IRA is a tax strategy in which high-income taxpayers are able to access the benefits of a Roth IRA even though they exceed the income limits. With a backdoor Roth IRA, a high-income taxpayer who has a traditional IRA may convert the funds to a Roth IRA.
The transfer cannot be done tax-free. Because the traditional IRA had the benefit of tax-deductible contributions, you will have to include the amounts in income that you would have otherwise reported if you had simply withdrawn the funds from your traditional IRA without a conversion. However, if you make the transfer from your traditional IRA to a Roth IRA within the allowable 60-day time period, you will forfeit the 10% early withdrawal penalty on the conversion contribution.
Opening an IRA is a wise retirement investment decision. If youโve decided to open your own traditional IRA or Roth IRA, you can invest with confidence online while managing your own IRA with investment tools such as Empower.
Depending on your personal financial situation, there are several downsides to a Roth IRA.
Itโs wise to have both. To understand why, hereโs a look at how a 401(k) works.
A 401(k) is an employer-sponsored retirement account that allows employees to contribute a portion of their earnings directly to their retirement account. Employers may or may not also contribute to an employeeโs 401(k). Employer matchingโwhere an employer matches an employeeโs contribution to their 401(k)โis one way companies encourage their employees to take advantage of the 401(k) option.
If your employer offers an employer match, you should contribute the full amount that the company matches to maximize the total compensation you receive from your employer. It is common for employers to offer a 50% to 100% match on a certain percentage of its employeesโ contributions. If your employer offers a 50% match on the first 6% of your income, for example, you should contribute 6% in order to get the 3% match from your employer.
Each year, the IRS releases its contribution limits for 401(k)s, just as it does for Roth IRAs. The IRS sets much higher contribution limits on 401(k)s. In 2023, the limit for employee elective deferrals was $22,500. If youโre age 50 or over, you are allowed an additional $7,500 in catch-up contributions for a total of $30,000 in contributions. In 2024, the base limit rose to $23,000 (the catch-up contribution remained the same, for a $30,500 total limit for those 50+).
The bottom line: You can have both a Roth IRA and a 401(k). That combination gives you the benefit of your tax-deferred 401(k) at work and tax-free withdrawals in retirement from your Roth IRA.
Yes, you can and should contribute to both a Roth IRA and a traditional IRA. Savvy financial planners suggest you diversify your investments. If you have both a Roth IRA and a traditional IRA, you will have some money that you can withdraw from your Roth IRA tax-free in retirement while still benefiting from the tax deductions of traditional IRA contributions over many prior years.
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