Before we delve into the question, let's briefly review the differences between a Traditional IRA and a Roth IRA. That comparison can provide a foundation for the topic.
First, a Traditional IRA (Individual Retirement Account) allows the holder to make contributions using pre-tax funds in many cases. The IRA was created as a tool for workers who did not have access to an employer-sponsored retirement account like a 401(k). You make your contributions with money you don't pay income taxes on (either federal or state). The reasoning is that when you retire and take withdrawals, you will be in a lower tax bracket.
In contrast, you fund a Roth IRA with money you have already paid taxes on, both federal and state (if applicable). If you expect to be in a higher tax bracket in retirement than when you are making the contributions, a Roth IRA makes sense. Also, it’s crucial to note that the earnings in a Roth IRA are not taxed. The growth in a Traditional IRA is merely tax-deferred since you will pay taxes on withdrawals, including both contributions and growth.
Another distinction relates to mandatory distributions: the Traditional IRA requires that the owner take distributions beginning at age 72, while a Roth IRA has no mandatory withdrawals.
How much can I contribute to an IRA?
The contribution limit for investing in an IRA in 2023 is $6,500 (unless your taxable income is less than that, in which case your income is the maximum). If you are aged 50 or more, the limit is $7,500. The contributions are tax-deductible if you don’t have an employer-sponsored 401(k) or similar plan. If you do have an employer-sponsored plan, the limit on what you can contribute to an IRA is determined by your MAGI (modified adjusted gross income). For a single filer, the MAGI limit for any tax-deductible contribution tops out at $83,000, or $136,000 for a married couple filing jointly. In the case of a couple, there is a different limit when one spouse is eligible to invest in a workplace plan, and the other is not.
The limits are the same for contributions to a Roth IRA, but higher earners may not be eligible to make contributions, depending on their income. The limits apply to your total contributions to either type of IRA.
Who should invest in a Roth IRA?
Whether it's wiser to contribute to a Roth or Traditional IRA depends on your current and anticipated future tax brackets. For example, if you expect that your income is higher now than it will be later, it may make sense to focus on the Traditional IRA. On the other hand, if you think your future income tax obligation will be higher (due to income or the expectation that taxes may rise), the Roth might be a better option. Also, if you prefer to avoid mandatory minimum distributions, the Roth makes sense.
In either case, your withdrawals from a Roth IRA won’t be taxed at the federal or state level. Instead, you will pay the applicable taxes when you contribute to the account.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
