We all know we should save for retirement, but what does that mean? There are various things to decide each year when it comes to your retirement savings. How much should you save? What kind of retirement account should you fund? How should you invest your money once it gets into the retirement account? A great and simple way to save for your retirement (with potential tax savings) is through an Individual Retirement Account (IRA).
Benefits of Traditional IRA vs. Roth IRA
For eligible taxpayers, a traditional IRA offers a current tax savings opportunity in the form of a tax deduction for the amount of your contribution. Traditional IRAs are known as tax-deferred savings accounts. This means you save tax dollars today when the contribution goes into the account and pay taxes later when the principal and earnings come out of the account. Traditional IRA distributions are taxed at ordinary income tax rates. Consider holding inefficient tax assets in your Traditional IRA from an asset location standpoint.
Roth IRA contributions are not tax-deductible, but qualified withdrawals of principal and earnings are tax-free. Roth IRAs offer the advantage of tax-free growth. The growth can be substantial over time if you start contributing early on in your working years and let it grow until you retire. This option is attractive for a taxpayer with a lower tax bracket now, and a projected higher tax bracket in retirement. Consider holding growth assets in your Roth IRA from an asset location standpoint.
Rules, Eligibility, and Limitations for IRAs
Traditional and Roth IRAs have the following rules and limitations:
- For tax year 2022, the maximum contribution to Traditional and Roth IRAs combined is $6,000 per individual under age 50 and $7,000 per individual age 50 or older.
- For tax year 2023, the maximum contribution to Traditional and Roth IRAs combined is $6,500 per individual under age 50 and $7,500 per individual age 50 or older.
- Contributions are limited to taxable compensation for the year. For married-filing-joint taxpayers, one spouse’s taxable compensation may allow a spouse without sufficient taxable compensation for the year to contribute to their own IRA.
- You can withdraw your money at any time, though non-qualified withdrawals (generally distributions prior to age 59.5) may incur tax and penalties. There are certain exceptions to the age 59.5 rule; consult your tax advisor or visit https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions for more on the exceptions.
Depending on your filing status, income level, and whether you or your spouse are covered by a retirement plan at work, deductible traditional contributions and Roth contributions may be limited or completely phased out. For example, a married couple with a 2022 modified adjusted gross income of over $214,000 cannot contribute to a Roth IRA for tax year 2022. There are different rules for each fact pattern (filing status, covered by an employer plan, and modified adjusted gross income amounts). Visit the following link for the different income limitations based on your filing status and employer-sponsored retirement plan coverage. (https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits)
Is your income too high to contribute to Roth or deduct an IRA contribution? Consider a non-deductible IRA contribution. Ask your advisor whether a “back-door Roth IRA” may make sense for you.
DHJJ Financial Advisors Can Help
Don’t let another year go by without contributing to your Traditional IRA or Roth IRA. Ask your financial advisor or tax professional to assist in the specifics of your eligibility, including whether a traditional or Roth makes more sense for you should you qualify for both. DHJJ Financial Advisors helps clients plan for a strong financial future with retirement planning, including determining which retirement savings accounts work best for their unique situations.
Find out more about DHJJ Financial Advisors Retirement Planning by reading our insights.
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