Both traditional and Roth IRAs offer tax advantages that can have a substantial impact on your retirement savings, especially if contributions are made over a long period of time. But in order to figure out which account is right for you, you first have to understand how they differ from one another.
First Things First: How Much Can You Contribute?
If you're under age 50, you may be eligible to contribute up to $5,500 to traditional and Roth IRAs. Those age 50 or older may contribute an additional $1,000 catch-up contribution, bringing heir maximum contribution up to $6,500.
It's important to note that it's a combined limit. So you can't contribute $5,500 (or $6,500) per account, it's $5,500 (or $6,500) total for all your traditional and Roth IRAs combined.
Crucial Questions: How Old Are You and How Much Do You Make?
To contribute to a traditional IRA, you must be under the age of 70 ½ and earning taxable income. Roth IRAs, on the other hand, do not have any age restrictions. As long as you are earning taxable income, and meet certain income requirements, you can contribute.
How much money you earn determines how much you can contribute to a Roth IRA. In 2017, single filers must have a modified adjusted gross income (MAGI) of less than $118,000 to make full contributions. If your income falls between $118,000 and $133,000, you can contribute a reduced amount. Single filers with a MAGI of $133,000 or more cannot contribute to a Roth IRA at all.
Married couples filing jointly must have a MAGI of $185,000 or less to make full Roth IRA contributions. Contributions are limited for married couples with income at or over $186,000. Married couples who have a combined MAGI of $196,000 and above are not allowed to contribute at all.
If you're single and covered by an employer-sponsored retirement plan, like a 401(k), the deduction you can claim for a traditional IRA contribution is reduced once your MAGI exceeds $61,000, then is eliminated at $71,000. For married couples filing jointly, the deduction is reduced once your MAGI exceeds $98,000, and is eliminated at $118,000.
Married couples without an employer-sponsored retirement plan are not subject to income limitations on tax-deductible contributions. However, if you are not covered by an employer-sponsored plan, but your spouse is, your contribution is fully deductible only when your combined income is less than or equal to $186,000, partially deductible for incomes below $196,000 and not deductible for incomes beyond that.
The Key Difference: Pay Taxes Now or Pay Taxes Later?
With traditional IRAs, taxes are paid upon withdrawal. Your contributions are generally tax deductible up to the maximum annual limit, and normal income tax rates apply. While Roth IRA contributions are not tax deductible, withdrawals are tax free provided you're over the age of 59½ or meet some of the special criteria detailed in the next section.
If you think that your income and, therefore, your income tax, is likely to be higher as you approach retirement than it is now, you might prefer a Roth IRA. If you think that your income will be lower as you approach retirement, a traditional IRA may offer more of an advantage.
Happy Half Birthday: The Rules for Withdrawals
Once you reach age 59½, you can withdraw money from both traditional and Roth IRAs without running afoul of the 10% early withdrawal tax penalty.
There are situations where you can withdraw funds before the age of 59½ without incurring any tax penalties. This includes, but is not limited to, situations in which you:
- Intend to pay for college tuition for you or a dependent
- Intend to pay for a qualified first-time home-purchase expense
- Become disabled
- Need to pay for qualified health insurance premiums and medical expenses
On top of all that, you can't take a tax-free distribution from a Roth IRA until five years have passed since your first contribution.
According to IRS rules, you're generally required to start taking required minimum distributions (RMDs) from traditional IRAs when you reach age 70½, on or before April 1 of the following year. Failure to do so will result in an excise tax on the amount that should have been distributed.
You're not required to take distributions from Roth IRAs, however. You can leave the funds in the Roth IRA throughout your lifetime and other income tax deferral opportunities may be available to your beneficiaries.