Retirement planning is a necessity. That’s why it’s imperative to maximize your contributions to your personal retirement fund by understanding the differences between a Roth IRA and traditional IRA and how much you can fund to each. Meeting with your accountant can help you reach your full potential in retirement earnings.

Roth versus Traditional IRA

While both types of IRAs, Individual Retirement Arrangements, help you achieve financial stability during your retirement years, they both have differences that could make one the better personal option depending on your current financial lifestyle and age. Both, however, can be contributed to at any age up to a certain amount (not to exceed your earned income) depending on your circumstances (married, single, and additional plans) by April 15^th each year.

Roth IRA

The biggest notable difference between the two arrangements is when the tax break is received. With the Roth IRA, taxes are paid at the time of contribution of your after-tax dollars, and, when funds are withdrawn after 59 ½, no additional taxes are due. This is why a Roth IRA is typically recommended for the younger generation when the tax rate is typically lower. Best of all, your money accrues tax-free, and withdrawals can be made penalty (and tax) free after 59 ½ years of age. While early withdrawals on the initial contribution can be made penalty-free, if earnings from interest are withdrawn, a 10% fee is assessed. Another perk to a Roth IRA is that within a person’s lifespan, RMDs (required minimum distributions) are not required. A negative aspect often associated with the Roth IRA is that contributions cannot be used as a tax deduction, unlike its’ counterpart.

Traditional IRA

Separate from the Roth IRA, the traditional IRA contributions are tax deductible and can be made without being taxed. However, once mandatory distributions start at the age of 70 ½, income taxes are deducted similar to receiving a paycheck. So, instead of receiving your tax break in your retirement, it’ll be given in your younger years – which is great if upon contributing, you’re in a higher tax bracket. Another difference, and disadvantage, to the traditional IRA, is that any withdrawals from the arrangement are subject to a 10% penalty on the original deposit and earnings (some exceptions apply such as medical bills).

Contribution limits

As mentioned earlier, there are limitations on contributions to each arrangement. Depending on your circumstances, you may not be able to contribute to one at all directly. The main contributing factors to how much can be deposited are the modified adjusted gross income (MAGI), tax filing status, and participation in other retirement plans (such as the 401K).

With both types of IRA for the year 2022, if you’re under the age of 50, the maximum yearly contribution is $6,000, and for those 50 and older, an additional $1,000 may be contributed.

With a traditional IRA, as long as there are no additional retirement plans, a contribution can be made as long as there is earned income, and there are no income limits. With additional retirement plans, a contribution can be made, but a full deduction is no longer eligible. If you file as married, a contribution can be made even if you don’t have earned income as long as your spouse does.

For the Roth IRA, if your MAGI is closer to the maximum range given, the maximum contribution amount will be reduced.

Roth IRA Income Limits 2022
Filing Status	Income Range
Single	$129,000-144,000
Married, filing jointly	$204,000-214,000
Married, filing separately	$0-10,000

 

To figure out your maximum contribution:

1. Start with your MAGI
2. Subtract your MAGI from the maximum amount in the chart above
3. Divide the result by the range for your filing status
4. Multiply the number from 3 by the maximum contribution limit
5. Subtract the result from the previous step from the maximum contribution limit

For Example:

What is the contribution limit for someone who is single and makes $135,000 a year?

Note that someone who files as single has the range of $129,000-144,000.

1) MAGI= $135,000

2) Max amount $144,000 – $135,000 = $10,000

3) $10,000/15,000(from 129,000-144,000) = .67

4) .67 x $6,000(the maximum contribution limit) = $4,020

5) $6,000 – $4,020 = $1,980

Due to the higher MAGI, the maximum contribution for this person is now $1,980.

Rollover Contributions and the Backdoor Roth IRA

Using the backdoor method is an option if your income is too high to contribute to a Roth IRA in the traditional manner. Going this route entails opening a traditional IRA or 401k account, and then converting the funds from one of the accounts to the Roth IRA. There are three ways that this can be achieved:

1) Contributing funds to a traditional account and then rolling over/converting the funds to a Roth IRA.

2) Converting the entire traditional IRA to a Roth IRA

3) Converting a 401K account into a Roth IRA (this is not always an option)

Converting from a traditional IRA or 401k to a Roth IRA is beneficial for the agreement holder, because, with the Roth IRA, there are no RMDs, balances grow tax-free, and balance withdrawals after 59 ½ are available tax-free. Upon conversion, taxes are paid for pre-tax dollar contributions.

Taxes on Contributions Over the Limit

It’s imperative to understand your maximum contribution amount to not only contribute as much as possible but to ensure that too much isn’t funded to your account. If an excess contribution is made, a 6% tax fee is assessed per year that the funds are in the IRA. To avoid and stop the fee, the contribution and any earnings from the excess contribution must be removed by the due date of the personal tax return, April 15th.

Your Retirement

The thought of retirement can be daunting to many people, but, with proper planning, it doesn’t have to be. An individual retirement agreement is a great way to ensure a happy, comfortable retirement. Kislay Shah CPA can help by discussing your best options to meet your goals and exactly what it will take to achieve them.