There are many ways to save for retirement. But one of the best is to get an individual retirement account (IRA). These are especially useful if you don’t have access to a workplace retirement account, like a 401(k) or 403(b). An IRA is essentially a shell into which you deposit and invest money for the purpose of growing your retirement savings. Workplace retirement accounts are generally filled with pre-tax money. But with IRAs, this tax question depends on which type of IRA you decide to open. For help managing your retirement plans, consider working with a local financial advisor.
Traditional IRA Taxes
A traditional IRA allows you to make pre-tax contributions. This means you don’t pay taxes on the money you deposit into the account. This tax-deferred status means you’ll pay taxes on withdrawals during retirement. Just be aware that withdrawing funds before age 59½ typically incurs a 10% IRS penalty.
For 2024 and 2025, the annual contribution limit for traditional IRAs is $7,000. If you’re age 50 or older, you can make an additional catch-up contribution of $1,000. This brings your total allowable contribution to $8,000.
It’s important to note that while you can contribute to both a 401(k) and a traditional IRA, the deductibility of your IRA contributions may be affected if you or your spouse is covered by a retirement plan at work. The deduction may be reduced or phased out depending on your modified adjusted gross income (AGI) and filing status. For example, in 2024, if you’re a single filer covered by a workplace retirement plan, the deduction phases out between a modified AGI of $77,000 and $87,000.
Additionally, contributions to a traditional IRA can be made up until the tax filing deadline for that year. For instance, you can make contributions for the 2024 tax year until April 15, 2025.
Keep in mind that required minimum distributions (RMDs) must begin by April 1 following the year you reach age 73, as per current IRS regulations.
And remember, you can always consult with a tax professional or financial advisor to understand how these rules apply to your specific situation. They can also help you optimize your retirement planning strategy.
Roth IRA Taxes
For the most part, a Roth IRA operates similarly to a traditional IRA. You start by putting money into the account, investing and letting it grow and eventually taking out distributions when you retire. Roth IRAs also have the same contribution limits as traditional IRAs. They allow for contributions of $7,000 per year, unless you’re over 50, in which case you can contribute up to $8,000.
The major difference between Roth and traditional accounts is that Roth IRA deposits are already taxed and not deductible on your tax return. But that means when you’re ready to take the money from your account, it won’t be taxed. This is understandably an appeal proposition for most people.
For the 2024 tax year, there are also income limits that determine how much you can contribute to a Roth IRA. If you’re single, you can contribute the full amount if you earn $146,000 annually or less. But if you earn between $146,000 and $161,000, you can contribute a lesser amount. Earners over $161,000 are not allowed to contribute.
For a married couple who files jointly, total earnings of up to $230,000 allow you to contribute the full amount. Between $230,000 and $240,000, a partial contribution is allowed. With earnings of more than $240,000, no Roth IRA contributions are allowed.
Traditional IRAs vs. Roth IRAs: Which Tax Setup Is Best for You?
There are positives and negatives to the tax implications of both traditional and Roth IRAs. A traditional IRA allows you to defer taxes until retirement, enhancing your account’s growth potential during your working years. Once retired, you may be in a lower tax bracket, making withdrawals more tax-efficient. Additionally, some states do not tax retirement income, providing further savings.
In contrast, a Roth IRA offers greater clarity on your retirement savings since contributions are made with after-tax dollars. This eliminates the need to account for taxes on withdrawals, simplifying retirement planning and enabling a more defined strategy for achieving your desired retirement lifestyle. The tax-free withdrawals can be a significant advantage.
Bottom Line
Whether or not money put into an IRA is taxable depends on which type of IRA you open. With a traditional IRA, the money avoids taxes now, but you’ll owe taxes on the withdrawals you take from the IRA in retirement. On the other hand, with a Roth IRA, you’ll put money in after taxes, with no taxes on your distributions. Which type of IRA is right for you depends on your goals and future trajectory. Beyond that, building a retirement plan is a very personal process. If you have questions about how the specifics of your financial situation should govern which type of IRA you open, think about working with a financial advisor.
Retirement Planning Tips
- It’s important to know exactly how much you’ll need to have in retirement based on your lifestyle, where you live and when you plan to retire. SmartAsset’s retirement calculator can help you figure that out so you can plan with goals in mind.
- A financial advisor can help you set up a robust retirement plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area. You can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- One of the keys to saving for retirement is a strong asset allocation. It should change as you age, going from an aggressive equities-based portfolio aimed at building wealth to a more conservative portfolio focused on preserving wealth during retirement. Use SmartAsset’s asset allocation calculator to start building your portfolio.
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