A Tax and Financial Advisor’s Guide to IRAs
Updated February 2023
IRAs may seem complicated, but as a tax and financial advisor located in Highlands Ranch, we are here to help. Individual retirement accounts (IRAs) are a type of tax-advantaged account that can help you boost your retirement savings. The most common IRAs you’ll choose from are traditional IRAs and Roth IRAs. Both are designed for tax-advantaged long-term growth, but there are some key differences, including how your contributions are taxed and when you can withdraw funds. Here is a breakdown of the two most common IRA accounts and a look at how to choose the one that’s right for you.
Traditional IRA
Anyone age 18 and older with an earned income can make contributions to a traditional IRA of up to $6,500 a year in 2023. Those age 50 and older can contribute up to $7,500. Contributions are tax-deductible, and your savings grow tax-deferred. You may begin making withdrawals at age 59 ½, and you must take required minimum distributions (RMD) at age 73. In 2033, the RMD age will move to 75. Withdrawals are subject to income tax, and early withdrawals before age 59 ½ may be subject to a 10% penalty.
Your ability to deduct contributions to a traditional IRA is dependent upon your income. Married couples filing jointly with a modified adjusted gross income (MAGI) of up to $116,000 ($218,000 if only one spouse is a participant in a qualified plan) can deduct the full amount, as can single filers with a MAGI of up to $73,000. If you exceed these income limits, you can still make partial deductions until eligibility is phased out for singles making between $73,000 and $83,000 and jointly-filing married couples making between $116,000 and $136,000.
Roth IRA
Contributions to a Roth IRA are made with after-tax dollars, and money inside the account grows tax-free. The annual contribution limit for a Roth IRA is also $6,500, or $7,500 for those age 50 and older.
If you are over age 59 ½, you can withdraw funds at any time and there are no minimum distribution requirements. Regardless of age, you can withdraw your contributions at any time without paying penalties or taxes. However, if you withdraw earnings before you reach age 59 ½, you may have to pay penalties and taxes. You may also need to pay taxes and penalties on withdrawals if you’ve been making contributions to your Roth IRA for less than five years.
Only those with incomes of less than $138,000 for single filers and $218,000 for married couples filing jointly can contribute to a Roth IRA. If you earn more than that, you can still make partial contributions if your income is greater than or equal to $138,000 but less than $153,000 for a single person and greater than $218,000 but less than $228,000 for married couples filing jointly.
Choosing Which Account is Best for You
The main difference between a traditional IRA and a Roth IRA is how and when contributions are taxed. You can deduct contributions to a traditional IRA and lower your taxable income for the year in which you made the contributions, but you will pay taxes on your withdrawals. Roth IRAs don’t offer immediate tax benefits — you make contributions with after-tax dollars — but withdrawals are tax-free.
When choosing between the two accounts, the best choice for you likely depends on whether you think your tax rate will be higher or lower in the future. If you anticipate a higher tax rate in retirement, a Roth IRA may be the better choice, since you pay taxes now at the expected-lower rate. And if you expect a lower income tax rate in retirement, a traditional IRA can offer you more tax advantages now since you can reduce your taxable income today and pay a lower income tax rate on withdrawals in the future. Consulting a tax and financial advisor will help you navigate the available choices.
Another key point to consider when deciding to fund either a traditional or a Roth IRA is that it is important to have diversity not only across asset types, but also account types. What do we mean? By having money in both pre-tax and post-tax accounts, you can be more strategic about staying within certain marginal tax brackets when it comes time to take distributions.
You don’t necessarily have to choose between the two accounts; it is also possible to contribute to both. Contribution limits are cumulative across accounts, so total contributions cannot exceed $6,500 ($7,500 for those 50 and older) in 2023.
Tax planning advisors will tell you that whether you choose to fund a traditional IRA, Roth IRA, or both, you’ll be taking advantage of tax benefits that can supercharge your savings and bring you closer to achieving your retirement goals. To learn more about securing your financial future, contact a Morgan Rosel Wealth Management tax and financial advisor today.
Sources:
https://www.irs.gov/retirement-plans/traditional-and-roth-iras
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