Roth vs Traditional IRA Income Limits

In life, there’s not many things that you can control. For example, you cannot control how old you are! As you get older, it can be harder to do the things you’re used to like working. In fact, that is why retirement exists! Retirement is when a person makes the decision to leave the workforce behind them. However, once someone makes the decision to go into retirement, that means they lose their source of income. When you lose your source of income, your ability to repay your bills can be nearly impossible. That is why you need to have a solid game plan when it comes time for you to retire.

How to Make a Retirement Game Plan

When it comes to making your retirement game plan, the key is preparation. There are some tips that you can keep in mind when it comes to getting together your plan for retirement. However, before we dive into the list we want to remind you that an online article cannot provide you perfect retirement advice. Instead, we can tell you about different opportunities that you can keep in mind when speaking to a professional like a retirement financial advisor. Now that we got that out of the way, let’s look at some tips like:

  • Plan Your Goals
  • Use an IRA
  • Autopilot Can Help

Plan Your Goals

When planning for retirement, it can be hard to measure success without having goals that you want to meet. That is why you want to plan for how much you’ll need. You will want to consider your monthly expenses. That means all of them! You also want to keep in mind how much money you want for traveling, holidays, and more. It can rack up when you aren’t working. There are tools online or companies that can help you better understand and predict what this number will be.

Use an IRA

Saving is key when it comes to reaching your goals. Luckily, there are plenty of different retirement accounts that are available for you to consider. One account specifically is called an Individual Retirement Account (IRA). There are two types of IRAs. There is a Traditional IRA and a Roth IRA. We will talk more on this below but these options can help you save for retirement all while providing tax benefits!

Autopilot Can Help

We live in the world of technology. What does that mean? Well at least when it comes to retirement you may benefit from automation. That’s why you should plan to try and automate what you can. Automating how much you put towards your retirement fund can take the brain work out of having to deposit money into your account. This can help make sure you put in money while not making it stressful to deal with.

What is a Traditional IRA?

We talked about using an IRA as a tool to help you for retirement. However, this option is so useful that we need to talk about it more in-depth. Like we said, there are two types of IRAs. There is a Traditional IRA and a Roth IRA. However, let’s start with the Traditional IRA.

This type of account gives people the opportunity to put funds that are pre-tax towards investments. These investments can grow tax-deferred. This type of account comes with tax benefits! That’s because the IRS won’t tax the withdrawals (also known as distributions) until they are taken out. Individuals that deposit funds (also known as contributions) can deposit as much as they want up to a dollar limit. While there are no minimum contribution requirements, there is a limit to how much you can put! A Traditional IRA is typically opened through a professional like a financial advisor, broker, etc.

Traditional IRAs: How Do They Work?

The funds that go into Traditional IRAs are pre-tax. The funds in these accounts can grow tax-deferred.  However that is only for the time they are in the account. However, once withdrawals occur then it’s a different story. It’s also important to note that withdrawals have guidelines around them. For example, retirement withdrawals must occur when the account holder is at least 59 years and 6 months old.

Since the funds that you put into the account are pre-tax, that means you can count them as a tax deduction when you pay taxes. Why is that helpful? Well when you take a tax deduction, you can essentially reduce the amount of income tax you are responsible for. That means less income that you pay taxes on!

However, you will still have to deal with taxes on these funds even after you deposit them. That’s because once a person takes out money from their account, the funds will face an ordinary income tax rate. The tax rate depends on the tax bracket you are in.

We also want to point out that there are contribution limits that you will deal with as well (like we mentioned earlier in the article). The limits can change every year. However, for both the 2021 tax year and 2022 tax year the contribution limit was:

  • $6,000 for individuals younger than 50 years old
  • $7,000 for individuals older than 50 years old

Understanding Distributions for Traditional IRAs

When you make a withdrawal, the IRS will view those funds as taxable income. Which means you will need to pay taxes like income taxes. There are some guidelines around distributions. Some of the rules include:

  • The account holder must be at least 59 years old and 6 months (59 ½)
  • Once the account holder is 72 years old they will need to take out required minimum distributions (RMDs)
  • Funds that are withdrawn before the retirement age of 59 years and 6 months old will deal with a penalty that can be worth up to 10% of the amount taken out as well as additional taxes at the typical tax rate.

It is important to note that there are exceptions that apply. If your situation meets an exception then it will not be subject to penalties (but you will still need to pay taxes). Some penalty exceptions include:

  • The distribution will go towards rebuilding or buying a first home for the account holder or qualifying family member (which has a $10,000 lifetime limit)
  • The account holder becomes disabled before the full retirement age
  • In the event of the account holder’s death, their beneficiary receives their assets
  • The assets go towards unreimbursed medical expenses
  • The distribution is in relation to the Substantially Equal Periodic Payment (SEPP) program
  • You put the assets towards higher education costs
  • You put the assets towards having a child (which includes adoption and has a $5,000 limit!)
  • The assets are used to pay for the cost of medical insurance if you are unemployed
  • The assets are in relation to an IRS levy
  • You’re in the military and are called to active duty for at least 179 days

Even though we can provide you with some examples, you will want to confirm with a professional like a tax attorney (or even the IRS) to see if your situation will deal with penalties. An article online cannot tell you whether or not you will be able to avoid tax penalties so speak to a professional!

What is a Roth IRA?

Now that you have a better understanding of Traditional IRAs, you should make sure you know about Roth IRAs. This can help you compare a Roth IRA and a Traditional IRA (but there will be more on that down below!). Anyways, a Roth IRA is a type of account that allows individuals to put after-tax funds into an account. The funds in the account can grow tax-free. Once the funds in the account are eligible, they can be withdrawn tax-free, too! That means you would not have to pay taxes on the money you take out. Many people like this account because of the fact it has less restrictions than other retirement account options. For example, a Roth IRA does not deal with required minimum distributions (RMDs).

Roth IRAs: How Do They Work?

Even though these types of accounts have less restrictions, that doesn’t mean there are none. There are still guidelines around this type of account that you want to keep in mind. Again, a Roth IRA is a type of account that is funded using after-tax dollars. That means that instead of being able to count Roth IRA contributions as a tax deduction upfront, the account holder will see the tax rewards later once they take out qualifying withdrawals since they are tax-free. People can use a variety of different types of funds when it comes to their Roth IRA contributions except for securities or property. There are limits when it comes to how much a person can deposit. The contribution limits can change every year. However, for both the 2021 tax year and 2022 tax year the contribution limit was:

  • $6,000 for individuals younger than 50 years old
  • $7,000 for individuals older than 50 years old

Understanding Roth IRA Distributions

Now that you understand the basics of a Roth IRA, it is time to make sure you understand what it means to have a qualifying withdrawal. There are no limits if you withdraw your contributions that are equal to the amount you put in. That means if you take out the amount that you put in then you will not have to worry about any penalties or taxes.

However, besides that exception, any account earnings that you withdraw must be an eligible distribution. A qualifying withdrawal is one that occurs at least 5 years after the account holder established and added funds into their account. Besides this, the withdraw must meet any of the following conditions:

  • The account holder is at least 59 years and 6 months old
  • The distribution will go towards rebuilding or buying a first home for the account holder or qualifying family member (which has a $10,000 lifetime limit)
  • The account holder becomes disabled before the full retirement age
  • In the event of your death, your beneficiary receives your assets

Now that you know what some qualifying distributions look like for a Roth IRA, it is important to understand what non-qualifying distributions look like. Any withdrawal that does not meet the above will be considered as non-qualifying. This means they will face taxes and a penalty worth up to 10% of the withdrawn amount. However there are exceptions to this! Some exceptions include:

  • The assets go towards unreimbursed medical expenses
  • You put the assets towards higher education costs
  • You put the assets towards having a child (which includes adoption and has a limit of $5,000)
  • The assets are used to pay for the cost of medical insurance if you are unemployed

Roth IRAs and Traditional IRAs: Comparing the Two Options

While it may seem like these two accounts are nearly identical thanks to their names, they are actually different but have similarities. Some key aspects that you need to keep in mind include:

  • Tax Benefits: Roth IRA vs Traditional IRA
  • Income Limits: Roth IRA vs Traditional IRA

Roth IRA vs Traditional IRA Tax Benefits

Each IRA option provides tax benefits. However not each account provides the same opportunity. When it comes to a Traditional IRA account, the funds that you deposit are made with pre-tax dollars. That means they can be used as a tax deduction when you file. Applying this tax deduction reduces the amount of income you pay income taxes on! However, since you see tax benefits right away, you won’t be able to expect them down the line. That’s because when you take out withdrawals by the retirement age you will deal with the ordinary tax rate since the withdrawals are seen as taxable income. If you withdraw the funds before your retirement age then you will still have to deal with taxes but you may deal with penalties too.

On the other hand, a Roth IRA is different. That’s because a Roth IRA is funded with after-tax dollars. That means the contributions cannot be seen as a tax deduction. However, even though people can’t see the tax benefits right away, they are still there. Instead, a person will see the benefits when it comes time to make a qualifying withdrawal. As long as the person is of retirement age and meets the 5 year rule, the money they take out of a Roth IRA will not deal with any taxes on earnings. Just keep in mind that if the person does not meet a qualifying distribution then it is subject to penalties and taxes.

Roth IRA vs Traditional IRA Income Limits

Luckily, even though understanding the tax differences can be confusing, it won’t be hard to learn the limits. For a Traditional IRA, there are no income limits. Anyone that is 18 years old or older that has earned income can deposit into a Traditional IRA. However, individuals may run into limits when determining how much could be tax-deductible.

On the other hand, it’s a different story when it comes to a Roth IRA. Let’s look at 2021 for example! The limits for a Roth IRA were:

  • $125,000 for a single filer
  • $198,000 for joint filers

What to Know About Modified Adjusted Gross Income (MAGI)?

MAGI is the household’s annual gross income after accounting for any tax-exempt interest income and certain tax deductions. The IRS uses MAGI in order to determine factors like whether your income meets the Roth IRA income limits.

Overall

When it comes to planning your retirement, there are plenty of accounts to consider. Two popular options are a Traditional IRA and a Roth IRA. Even though these accounts may be similar, there are some key differences that matter. Some key aspects that you need to keep in mind include:

  • Roth IRA vs Traditional IRA Tax Benefits
  • Roth vs Traditional IRA Income Limits

Knowing these differences are important because they can help you find which account is best for the goals you are trying to reach. For tax benefits, you want to keep in mind that each IRA option provides tax benefits. However with a Traditional IRA you will typically see tax benefits right away compared to a Roth IRA where you will generally see tax benefits at your retirement age.

For income limits, a Traditional IRA has no income limits. On the other hand, the limits for a Roth IRA were:

  • $125,000 for a single filer
  • $198,000 for joint filers

Article References

https://www.thebalance.com/what-is-retirement-2388822

https://www.ellevest.com/magazine/retirement/retiring-on-your-terms

https://www.investopedia.com/terms/t/traditionalira.asp

https://www.fidelity.com/retirement-ira/ira-comparison

https://www.investopedia.com/terms/m/magi.asp

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