There are two types of Individual Retirement Arrangements (IRAs): Traditional IRAs and a Roth IRAs. Several similarities and differences are listed below based on current law.
Traditional IRAs are retirement vehicles that provide tax-deferred growth. Individuals under the age of 50 may contribute the lesser of earned income or $5,500 in 2017. Individuals who have attained the age of 50 before the end of 2017 may contribute an additional “catch up” amount of $1,000. Therefore, the maximum contribution is $6,500 for 2017. Even those who do not have earned income may still establish a traditional IRA if his or her spouse has sufficient earned income. Contributions are not allowed after the attainment of age 70½.
The deductibility of contributions to a Traditional IRA depends on the individual’s active participation status in a company sponsored retirement plan. An active participant is an employee that has benefitted under the following types of plans: 401k, 403b, certain government plans, SEPs, or SIMPLEs. If an employee is not an active participant, the full contribution to a Traditional IRA is fully deductible. If an employee is an active participant, income tests exist to determine the deductibility of contributions. Active participants in a retirement plan cannot deduct IRA contributions if filing single with modified adjusted gross income over $72,000 or married filing jointly making over $119,000.
Withdrawals of pre-tax contributions and earnings are taxable when distributed. Withdrawals are penalty-free if you are over the age of 59½. Once an individual turns 70½, required minimum distributions (RMDs) must begin by April of the following year or a 50% excise tax is imposed on those RMDs. These distributions are subject to ordinary income tax.
Contributions to Roth IRAs are after-tax and grow tax-free. Roth IRAs have the same contribution limits as Traditional IRAs, If you have earned income, Roth IRAs also allow contributions after the age of 70½ while Traditional IRAs do not. However, individuals may only contribute to a Roth IRA if their income falls within the prescribed income limits regardless of whether they participation in a company sponsored retirement plan.
There are two major benefits of a Roth IRA. Withdrawals from a Roth IRA are both tax-free and penalty-free after age 59½ (assuming the account has been open for at least five years). Also, there are no RMDs that must be made during the life of the owner of the IRA.
To determine whether a Traditional or Roth IRA is right for you, it is important to speak with a fee-only, CFP® professional. They will help you make the right choice based on your financial situation and your long-term goals.
—Kirsten Simon MBA CFP®