appy 2022! Let’s all
be grateful for
successfully making
into yet another year. During the latter part of 2021 I had several clients reach out with questions that not only revolved around their 401k and how to navigate withdrawals, but also about the financial milestones we reach at certain ages. So, let’s start off with a big question our firm receives every year around this time.
What are the differences between a traditional IRA and Roth IRA?
There are many types of IRA’s, but two of the most common are the traditional IRA and the Roth IRA. The type of account you select can have a significant impact on your long-term household savings.
The biggest difference between a traditional IRA and Roth IRA is their classifications in the IRS tax code. A traditional IRA holds the benefit of tax deferral, which means that money going into it has pre-tax status. On the other hand, since a Roth IRA is funded with after-tax dollars, it gives the benefit of potentially tax-free distributions. On top of these differences, both types of accounts have different rules for distributions. Because of this difference and others, it is important to understand the fundamentals behind these two plans.
Let’s explore other differences that traditional and Roth IRAs have as well.
Income Limitations
People can open a traditional IRA and make contributions toward it if they received taxable compensation. Generally, compensation refers to wages, salaries, commissions, tips, professional fees, and other forms of earned income. Whether these contributions are tax-deductible will depend on the amount of income you earned and whether you, or your spouse, are covered by a workplace retirement plan. Should your income exceed
certain amounts, and one of you does have a retirement plan at work, your contributions may be limited. On the other hand, if neither of you is covered by a workplace retirement plan, you are permitted full deductions.
On the other hand, Roth IRAs come with no age restrictions. However, there are certain restrictions in terms of income.
If you are a single tax filer interested in contributing to a Roth IRA, your modified adjusted gross earnings in 2021 must be less than $139,000. In case of married couples, a modified AGI of less than $206,000 will qualify them for Roth contributions.
However, if a single person or a married couple wanted to benefit from full Roth deductions, that also comes with income limits. In 2021, a single person can only have an AGI of up to $124,000, while married couples filing jointly can only go up to $196,000.
Tax Treatment Advantages
Sure, tax advantages are available with both traditional and Roth IRAs, but the timing of when those advantages apply is important. Traditional IRA contributions are deductible from state and federal income taxes for the year in which the contributions were made. The trade-off is on the backend, when you withdraw money from your account.
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The biggest difference between a traditional IRA and Roth IRA is their classifications in the IRS tax code.