Learn the differences between a Roth IRA and a traditional IRA and whether you should choose just one or contribute to both.
Traditional IRAs vs. Roth IRAs: What Are the Differences?
The major distinction between a Roth IRA and a traditional IRA is the characterization of the money you contribute to each. Contributions to traditional IRAs typically are typically made with pretax dollars. You can claim a tax deduction for those amounts in the year you make them. Traditional IRA distributions from principal are therefore subject to taxation in the year you take them. Money in a Roth IRA grows tax-free if distributions are qualified: You’re age 59 1/2 or older at the time you make the withdrawal and you’ve held the IRA for at least five years.
IRA Contribution Limits
Your total IRA contributions are capped at $6,000 a year as of 2022, whether you have one type of IRA or both. But you’re permitted an additional $1,000 in catch-up contributions for a total of $7,000 if you’re age 50 or older. This contribution limit applies to all your IRAs combined. Your total contributions for all accounts combined can’t total more than $6,000 (or $7,000 for those ages 50 and up) if you have both a traditional IRA and a Roth IRA. You get to decide how to allocate the contribution. You can put $50 in a traditional IRA and the remaining $5,950 in a Roth IRA, or you can put the maximum amount in just one IRA. It’s up to you. Anyone who has taxable income during the tax year can make a contribution to an IRA, whether that income is the result of a wage-earning job or earned through self-employment. But income from interest, dividends, and capital gains doesn’t count as earned income for IRA contributions. You can’t contribute more to an IRA than you earned in the year. You could only put $4,000 into an IRA if your taxable income was $4,000. But a married worker can contribute to a spousal IRA on behalf of their spouse if their spouse didn’t earn income during the year.
How Your Income Affects IRA Contribution Limits
Some high-income taxpayers have IRA contribution deduction limitations, but income doesn’t affect your ability to make traditional IRA contributions. It only affects whether you can claim a tax deduction for contributing that money. Roth IRA contributions are different. Certain upper-income taxpayers can’t contribute to Roth accounts due to restrictions associated with these accounts. Your taxable income can’t exceed $144,000 in 2022 if you’re single or file as head of household. The limit is $214,000 if you’re married and file a joint return. You can contribute a portion of the $6,000/$7,000 limit if your income falls between $129,000 and $144,000 and you’re single or head of household, or between $204,000 and $214,000 if you’re married and file a joint return. You can only contribute up to the full limit if you earn less than $129,000 or $204,000 respectively. Married taxpayers who file separate returns and who lived with their spouses at any time during the tax year are subject to much more stringent limits: just $10,000 in income, and they can only make partial contributions. They don’t qualify for the full $6,000 or $7,000 limit at all.
Should You Contribute to a Traditional and a Roth IRA?
You can contribute to both types of IRAs as long as you meet all the requirements. You’ll reap the immediate benefits of tax-deductible contributions if you contribute to a traditional IRA. You’ll potentially get the long-term benefits of tax-free retirement income if you contribute to a Roth. You can determine which option is best for you by running a few simple calculations. Ask yourself whether you expect your income to rise or fall over time, and whether you expect your tax bracket to be higher or lower after you retire. Plot a few scenarios using this information to see what the effects of your investment choices might be. It’s hard to predict where tax rates are headed in the future, so it helps to know that you can get the best of these account types by making contributions to both a traditional and a Roth IRA when possible.
