Traditional or Roth IRA?
Understanding the contribution, age and income rules in 2021
There are two popular Individual Retirement Accounts (IRAs) vying for your attention: the traditional IRA and the Roth IRA. While both are long-term retirement savings vehicles with tax benefits, each has different rules concerning contributions, age, and income that may change from one year to the next. It can be confusing to figure out which one is the right one for you.
Perhaps the biggest difference between traditional IRAs and Roth IRAs is how and when taxes apply to the contributions and the earnings. Contributions to traditional IRAs can be deductible on the taxpayer’s income tax return.
While contributions and earnings accumulate on a tax-deferred basis, income taxes are due when distributions are taken from the IRA. Alternately, contributions to Roth IRAs are made with after-tax dollars, and contributions and earnings accumulate tax free. No income tax is due when distributions are taken from a Roth IRA. For tax year 2021, the maximum contribution to either a traditional IRA or Roth IRA is $6,000 ($7,000 for individuals age 50 or older due to the catch-up provision).
Contributions to traditional IRAs can be made in the years in which an individual receives compensation. Required minimum distributions (RMDs) must generally begin when the individual reaches age 72 (70 ½ if they reached 70 ½ before January 1, 2020). It is imperative to begin taking these RMDs because a considerable tax penalty may apply if they are ignored.
Conversely, Roth IRAs have no minimum distribution requirements. However, both traditional and Roth IRAs have a minimum age for distributions: 59½. Distributions taken prior to age 59½ may be subject to a 10% Federal income tax penalty. This penalty is in addition to any tax consequence for the withdrawal. Certain situations qualify as exemptions, such as distributions to pay first-time-homebuyer expenses or qualified education expenses. Furthermore, before tax-free distributions can be received from a Roth IRA, the account must be at least five years old.
Income Eligibility Limits
Depending on your tax-filing status, your income, and whether or not you participate in a qualified employer-sponsored retirement plan, you may be eligible to take an income tax deduction for contributions to a traditional IRA.
If you are a single taxpayer, do not participate in a qualified employer-sponsored plan, and earn a minimum of $6,000, contributions are deductible regardless of your adjusted gross income (AGI). However, if you do participate in an employer-sponsored retirement plan, income limits apply. Deductions in 2021 phase out for single filers with modified AGIs (MAGIs) between $66,000 and $76,000, and for married couple joint filers with MAGIs between $105,000 and $125,000.
The income eligibility requirements are different for Roth IRAs. If you participate in a qualified employer-sponsored retirement plan, you may contribute to a Roth IRA; however, if you are also contributing to a traditional IRA, your contributions may not exceed the annual contribution limits. You are eligible to make a full contribution to a Roth IRA if your MAGI in 2021 does not exceed $125,000 for single filers or $198,000 for married joint filers (contributions phase out for single filers with MAGIs between $125,000 and $140,000, and for married joint filers with MAGIs between $198,000 and $210,000). For a married individual filing separately who participates in a workplace retirement plan, the phase-out range is $1 to $10,000.
A Roth IRA is often a favored choice for those who participate in a qualified employer-sponsored retirement plan and exceed the income limits for a deductible IRA, but who meet the income eligibility requirements for a Roth IRA.
As you investigate which IRA – or combination of IRAs – offers you the best option to save for retirement, you may want to consider the following questions:
• What tax benefits, current and long-term, are available to you?
• When do you anticipate needing your IRA proceeds?
Talking with a qualified financial professional about your personal financial situation is never a bad idea. They can help you develop a financial strategy to meet your specific retirement needs. Getting an analysis and scrutinizing the details now could save you time and money in the future.