The Roth IRA presents a potentially
attractive alternative to the traditional IRA. That's because a
Roth IRA may allow you to avoid future taxation of your retirement
funds by making nondeductible contributions now.
Rules of the Roth
Following is a summary of the rules for
Unlike the traditional IRA,
contributions to a Roth IRA are
nondeductible regardless of your income
level or participation in a company-sponsored retirement
Your total annual contributions
to all IRAs are limited to $6,000 in
2021. Individuals who are at least 50
years old by the end of the year are also able to make so-called
catch-up contributions to a Roth IRA. The allowable catch-up
contribution is $1,000 per year but is not adjusted for inflation.
The contribution limit begins to decline or "phase out" for single
taxpayers with adjusted gross incomes (AGIs) of more than $125,000
and for married couples filing jointly with AGIs of more than
$198,000. Individuals with AGIs in excess of $140,000 ($208,000 for
married couples filing jointly) are not eligible to contribute to a
Roth IRA. Married taxpayers filing separately are not allowed to
contribute to a Roth IRA if their AGI is $10,000 or
Contribution limits may increase
in the years ahead. In the future, the
annual contribution limit may be adjusted for inflation.
Qualified distributions from a
Roth IRA are tax free. While your
contributions to a Roth IRA are never tax deductible, your
distributions may be tax free if you have owned the Roth IRA for at
least five tax years, and:
- You are at least 59½ years old;
- Your withdrawal of up to $10,000
(lifetime limit) is applied to a first-time home purchase;
- You die or become permanently
You may qualify for the "first-time home
purchase" if you have not owned a home for at least two years
before the date on the purchase contract or the date when
construction started. You, your spouse, or a child, grandchild, or
ancestor of either may qualify as the buyer.
The taxable portion of a
nonqualified distribution may be subject to a 10% tax
penalty. If you make withdrawals that do
not meet the rules for a qualified distribution, you'll owe taxes
on all or a portion of the withdrawal. You must also pay a 10%
penalty tax on the taxable portion of the withdrawal, unless an
Penalty-free withdrawals are
permitted for qualified education
expenses. If you are under age
59½ but have held the Roth IRA for five tax years, you may
withdraw funds penalty free to pay for qualified education expenses
for yourself or family members. You will have to pay income tax on
the taxable portion of the distribution, however.
Retirement plan "rollovers" are
permitted. If you are changing jobs or
retiring, you can roll over funds from an employer retirement plan,
such as a 401(k) account, directly to a Roth IRA. The rollover is
treated as a conversion, with income taxes due on any previously
Roth IRAs are not subect to
minimum distribution rules. Unlike
traditional IRAs, which generally require account holders to begin
taking minimum distributions no later than age 72, Roth IRAs
The Traditional IRA vs. the Roth
When deciding whether a traditional IRA
or a Roth IRA is suitable for you, you'll want to compare the
after-tax dollars that would be available to you under each option.
This will depend on many factors, including your tax bracket, how
many years you have until retirement, and when you wish to begin
making withdrawals. For many people, a Roth IRA will result in more
after-tax income during retirement because qualified withdrawals
from a Roth IRA are tax free, while withdrawals from a traditional
IRA will be taxed (to the extent includible in income).
For those whose contributions to a
traditional IRA are tax deductible and who are in a higher tax
bracket today than they will be in during retirement, a traditional
IRA may be the smart choice.
If neither you nor your spouse
participate in a company-sponsored retirement plan, you can make
deductible contributions to a traditional IRA regardless of your
income level, up to the lesser of 100% of your earned income or
$6,000 in 2021 (or $7,000 if you are at least 50 years old).
Deductible contributions may be reduced or eliminated for
individuals who participate in a company-sponsored retirement plan
or whose spouses do, based on their incomes.
The traditional IRA may still provide an
advantage over the Roth IRA to those who maximize its benefit.
Here's how: You invest the tax savings from your IRA deduction in a
taxable investment account each year and let that account grow
along with your IRA. Assuming your tax rate drops in retirement,
this could yield more of a tax-adjusted benefit than a Roth
Conversion of a Traditional IRA
to a Roth IRA
There are no income limits associated
with the conversion of a traditional IRA to a Roth IRA -- anyone
can convert, provided they pay the tax bill. Since the investment
earnings and gains in your regular IRA have not been taxed yet,
these are taxable at the time of the conversion. If you have made
nondeductible contributions to a traditional IRA, earnings will be
taxed but your nondeductible contributions will not.
Which Is Right for
If you have a traditional IRA and are
considering converting to a Roth IRA, here are a few factors to
- A Roth IRA may be more
attractive the further you are from
retirement. Why? Because the longer your
earnings can remain invested, the more income you may have that is
never taxed. On the other hand, if you convert to a Roth IRA close
to retirement, your investments may not have much time to help
compensate for the associated tax bill.
- If your traditional IRA
contributions are nondeductible, you may be better off with a Roth
IRA. That's because the distributions of
earnings from your traditional IRA will eventually be taxed. The
qualified distributions from a Roth IRA will not.
- Your current and future tax
brackets will affect which IRA is best for
you. For example, if you are currently
in a high tax bracket and expect to be in a much lower tax bracket
during retirement, a traditional IRA could be the better
option. Why? Because you may be able to claim a deduction on
your contributions now and then pay taxes on future distributions
at the lower rate later.
As you can see, there is no easy answer
to the question, "Which IRA is best for me?" As with any major
financial decision, careful consultation with a financial
professional is a good idea before you make your choice. In
addition to helping you with calculations and projections, a
financial professional is also likely to know what, if any, changes
or clarifications have been made to the complex new tax laws.
Remember, your retirement could last 20 years or more. How you live
tomorrow could depend on the choices you make today.
The information contained herein is
general in nature and is not meant as tax advice. Consult a tax
professional as to how this information applies to your