What is an Individual Retirement Account (IRA)?

Category

Traditional/Rollover IRA

Roth IRA

Tax Advantages

• Contributions may be tax-deductible if you meet certain income and coverage limits.

• Earnings grow tax-deferred; you pay taxes when you withdraw funds in retirement.

• Potential to reduce your taxable income in the contribution year.

• Contributions are not tax-deductible (made with after-tax dollars).

• Earnings grow tax-free; qualified withdrawals in retirement are tax-free (if account is ≥5 years old and you’re ≥59½).

• Potentially pay $0 taxes on qualified distributions, which can be a big advantage later.

Eligibility

• Anyone with earned income can contribute (no upper age limit after SECURE Act).

• Deductibility depends on your filing status, income, and if you’re covered by a workplace plan.

• Anyone with earned income below certain thresholds can contribute, regardless of age.

• Income limits apply for direct Roth contributions; if your income is too high, you cannot directly contribute.

• No age limit to contribute, as long as you have earned income

Income Limitations

• No specific income cap to make a contribution, but tax deductibility phases out at higher incomes if you or your spouse is covered by a workplace plan.

• If you exceed certain Modified AGI thresholds, your deduction may be reduced or eliminated (though you can still do a non-deductible contribution).

• Direct contributions are limited if your Modified AGI is above certain thresholds (varies by filing status).

• If your income is too high, you cannot directly contribute (though some people use a “backdoor” Roth strategy).

Contribution Limits

• Under 50: $7,000

• 50 or older: $8,000

• Contributions can be tax-deductible if you meet certain eligibility rules (income limits, coverage by employer plan).

• Under 50: $7,000

• 50 or older: $8,000

• Contributions are always after-tax (no immediate deduction), but you must meet certain income thresholds to contribute directly.

When Taxes are Paid

• Contributions: potentially reduce taxable income in the year of contribution.

• Withdrawals: taxed as ordinary income upon distribution. If you withdraw before age 59½, typically a 10% penalty applies unless an exception is met.

• Contributions: paid with after-tax money, so no immediate deduction.

• Withdrawals: qualified distributions (age ≥59½ and account ≥5 years) are tax-free on both contributions and earnings.

Withdrawal Rules

• Generally can’t withdraw before 59½ without a 10% penalty (plus taxes).

• At retirement: all distributions taxed as ordinary income.

• Contributions can be withdrawn any time (tax/penalty-free), but earnings withdrawn before 59½ (and the 5-year rule) may incur taxes + 10% penalty unless an exception applies.

• Qualified withdrawals are tax-free.

RMD Requirements

• Yes. Required Minimum Distributions (RMDs) start at age 73 for many individuals.

• No. Roth IRAs do not require distributions during the owner’s lifetime.

Example Scenario

Assumed:

• Alex, age 35, contributes $7,000/year from age 35 to 65 (30 years).

• Average return: ~6% per year.

• Tax bracket: 24% now, 22% in retirement.

• Assumes a lump-sum withdrawal at age 65 for illustrative purposes.

Contributions:

• Each $7,000 contribution may be tax-deductible (if eligible).

• Immediate tax savings each year: $7,000 × 24% = $1,680 in federal taxes (assuming full deductibility).

Withdrawal:

• Approximate total after 30 years: $553,000 (using a standard annuity formula).

• Distributions are taxed as ordinary income.

• If Alex withdraws all $553,000 at once in a 22% bracket:

- Tax owed: $553,000 × 22% = $121,660

- Net after tax: $553,000 – $121,660 = $431,340

• Subject to Required Minimum Distributions (RMDs) starting at age 73.

Assumed:

• Bella, age 35, contributes $7,000/year from age 35 to 65 (30 years).

• Average return: ~6% per year.

• Tax bracket: 24% now, 22% in retirement.

• Also assumes a lump-sum withdrawal at age 65 for illustration.

Contributions:

• Each $7,000 is contributed after-tax; no deduction now.

• No immediate tax savings, but future qualified withdrawals are tax-free.

Withdrawal:

• Approximate total after 30 years: $553,000 (using a standard annuity formula).

• Qualified withdrawals (≥59½ + 5-year rule) are tax-free.

• If Bella withdraws $553,000 in one lump sum, she pays $0 in federal taxes on that amount.

• No RMDs for the original owner’s lifetime.