The two most common types of IRA are the traditional IRA and the Roth IRA. It’s helpful to understand the difference between Roth and traditional IRA options when saving for retirement.
Traditional IRAs are funded with pre-tax dollars, while a Roth IRA is funded with after-tax contributions. The same annual contribution limits apply to both types of IRAs, including catch-up contributions for savers aged 50 and older. For 2024, the annual contribution limit is $7,000, with an additional $1,000 allowed in catch-up contributions. For 2023, the annual contribution limit is $6,500, with an additional $1,000 allowed in catch-up contributions.
Whether it makes sense to open a traditional or Roth IRA can depend on eligibility and the types of tax advantages you’re seeking. With Roth IRAs, for example, you get the benefit of tax-free distributions in retirement but only taxpayers within certain income limits are eligible to open one of these accounts. Traditional IRAs, on the other hand, offer tax-deductible contributions, with fewer eligibility requirements.
In weighing which is better, traditional or Roth IRA plans, it’s important to consider what you need each plan to do for you. Opening a Roth IRA vs. regular IRA can allow you to save money for retirement and invest it in a variety of ways. But you may find one type of tax break (i.e. tax-deductible contributions vs. tax-free distributions) more valuable than another.
The Differences Between Roth and Traditional IRAs
When choosing which type of retirement account to open, it’s helpful to fully understand the difference between Roth and traditional IRA options. Specifically, that means knowing:
- Eligibility rules for making contributions to a Roth or traditional IRA
- Tax treatment of both IRA contributions and IRA withdrawals, including early withdrawal penalties
- Required minimum distribution requirements
The IRS has specific guidelines governing who can contribute to an IRA, the amount of contributions you can make, and how you’ll pay taxes on the money you save for your retirement. Navigating the rules can seem confusing, so it’s helpful to look at each guideline individually to get a sense of whether a Roth or traditional IRA is the better fit.
Eligibility Differences
Anyone below age 72 who earns taxable income can open a traditional IRA.
Roth IRAs have no such age restriction—individuals can make contributions at any age as long as they have income for the year.
Roth IRAs, however, have a key restriction that a traditional IRA does not: An individual must earn below a certain income limit to be able to contribute. In 2024, that limit is $146,000 for single people (people earning more than $146,000 but less than $161,000 can contribute a reduced amount). For those individuals who are married and file taxes jointly, the limit is $230,000 to make a full contribution and between $230,000 to $240,000 for a reduced amount.
In 2023, that limit is $138,000 for single people (people earning more than $138,000 but less than $153,000 can contribute a reduced amount). For those individuals who are married and file taxes jointly, the limit is $218,000 to make a full contribution and between $218,000 to $228,000 for a reduced amount.
The ceilings are based on modified adjusted gross income, which is basically the adjusted gross income listed on one’s tax return with certain deductions added back in.
Tax Differences
With a traditional IRA, individuals can deduct the money they’ve put in (aka contributions) on their tax returns, which lowers their taxable income in the year they invest. Come retirement, investors will pay income taxes at their ordinary income tax rate when they withdraw funds. This is called tax deferral. For individuals who expect to be in a lower tax bracket upon retirement, a traditional IRA might be preferable.
The amount of contributions a person can deduct depends on their adjusted gross income (AGI), tax filing status, and whether they have a retirement plan through their employer. This chart, based on information from the IRS , illustrates the deductibility of traditional contributions for the 2023 tax year.
With a Roth IRA, on the other hand, contributions aren’t tax-deductible. But investors won’t pay any taxes when they withdraw money they’ve contributed at retirement, or when they withdraw earnings, as long as they’re at least 59.5 years old and have had the account for at least five years.
For people who expect to be in the same tax bracket or a higher one upon retirement—for example, because of high earnings from a business, investments, or continued work—a Roth IRA might be the more appealing choice.
Contribution Differences
Contributions are the same for both Roth and traditional IRAs. The IRS effectively levels the playing field for individuals saving for retirement by setting the same maximum contribution limit across the board.
For the 2024 tax year the IRA contribution limit is $7,000, with an extra $1,000 contribution for those age 50 or older. Individuals have until the April tax filing deadline to make IRA contributions for the current tax year. To fund an IRA for the 2024 tax year, investors have until the April 2025 tax filing deadline to do so.
For the 2023 tax year the IRA contribution limit is $6,500, with an extra $1,000 contribution for those age 50 or older. Individuals have until the April tax filing deadline to make IRA contributions for the current tax year. To fund an IRA for the 2023 tax year, investors have until the April 2024 tax filing deadline to do so.
With a Roth IRA, investors can continue making new contributions into their account, regardless of age. That might appeal to an investor who plans to delay retirement past the traditional age of 65 or 66 and continue working. As long as a person has income for the year, they can keep adding money to their Roth account.
Traditional IRAs, on the other hand, don’t allow individuals to make contributions indefinitely. As long as a person is working, they can make contributions—but only up to age 72. After that, they can no longer continue putting money into their account.
Withdrawal Differences
Generally with IRAs, the idea is to leave the money untouched until retirement. The IRS has set up the tax incentives in such a way that promotes this strategy. That said, it is possible to withdraw money from an IRA before retirement.
With a Roth IRA, an individual can withdraw the money they’ve contributed (not counting any money earned in appreciation) at any time. They can also withdraw up to $10,000 in the earnings they’ve made on investing that money without paying penalties as long as they’re using the money to pay for a first home (under certain conditions).
With a traditional IRA, an investor will generally pay a 10% penalty tax if they take out funds before age 59.5. There are some exceptions to this rule, as well.
These are the IRS exceptions for early withdrawal penalties:
Disability or death of the IRA owner. In this case, disability means “total and permanent disability of the participant/IRA owner.”
Qualified higher education expenses for you, a spouse, child or grandchild.
Qualified homebuyer. First time homebuyers can withdraw up to $10,000 for a down payment on a home.
Unreimbursed medical expenses. These include health insurance premiums paid while unemployed and expenses greater than 7.5% of your AGI.
Required Minimum Distributions (RMDs) Differences
The IRS doesn’t necessarily allow investors to leave money in your IRA indefinitely. Traditional IRAs are subject to required minimum distributions, or RMDs. That means an individual must start taking a certain amount of money from their account (and paying income taxes on it) by April 1 of the year after they reach age 72—whether they need the funds or not. Distributions are based on life expectancy and your account balance.
If an individual doesn’t take a distribution, the government may charge a hefty 50% penalty on the amount they didn’t withdraw.
For those who don’t want to be forced to start withdrawing from their retirement savings at a specific age, a Roth IRA may be preferable. Roth IRAs have no RMDs. That means a person can withdraw the money as needed, without fear of triggering a penalty. Roth IRAs might also be a vehicle for passing on assets to your heirs or beneficiaries, since you can leave them untouched throughout your life and eventual death if you choose to.
The Takeaway
For most people, if not all, an IRA can be a great way to bolster retirement savings, even if one is already invested in an employer-sponsored plan like a 401(k).
When it comes to retirement, every cent counts, and starting as early as possible can make a big difference—so it’s always a good idea to figure out which type will work for you sooner than later.
This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.
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IRA Deduction and Contribution Limits For Taxes: Everything You Need Need to Know
Broadly speaking, individual retirement accounts, or IRAs, offer some sort of tax benefit — either during the year that contributions are made or when distributions take place after retiring. But not all retirement accounts are taxed the same.
With a traditional IRA, it’s possible for certain individuals to both invest for their future and reduce their present tax liability. For tax year 2023, the maximum IRA deduction is $6,500 for individuals younger than 50, and $7,500 for those 50 and older. For tax year 2024, the maximum IRA deduction is $7,000 for people younger than 50, and $8,000 for those 50 and older.
To maximize deductions in a given year, the first step is understanding how IRA tax deductions work. A good place to start is learning the differences between common retirement accounts — and their taxation. And since each financial situation is different, an individual may also want to speak with a tax professional about their specific situation.
Read on to learn more about IRA tax deductions, including how both traditional and Roth IRA accounts are taxed in the U.S.
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First, here’s a quick refresher on tax deductions for income taxes — the tax owed/paid on a person’s paycheck, bonuses, tips, and any other wages earned through work. “Taxable income” also includes interest earned on bank accounts and some types of investments.
Tax deductions are subtracted from a person’s total taxable income. After deductions, taxes are paid on the amount of taxable income that remains. Eligible deductions can allow qualifying individuals to reduce their overall tax liability to the Internal Revenue Service (IRS).
For example, Person X earns $70,000 per year. They qualify for a total of $10,000 in income tax deductions. When calculating their income tax liability, the allowable deductions would be subtracted from their income — leaving $60,000 in taxable income. Person X then would need to pay income taxes on the remaining $60,000 — not the $70,000 in income that they originally earned.
For the 2023 tax year, 22% is the highest federal income tax rate for a person earning $70,000. By deducting $10,000 from their taxable income, they are able to lower their federal total tax bill by $2,200, which is 22% of the $10,000 deduction. (There may be additional state income tax deductions.)
A tax deduction is not the same as a tax credit. Tax credits provide a dollar-for-dollar reduction on a person’s actual tax bill — not their taxable income. For example, a $3,000 tax credit would eliminate $3,000 in taxes owed.
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Traditional IRA tax deductions are quite simple. If a qualifying individual under age 50 contributes the maximum allowed to a traditional IRA in a year — $6,500 for the 2023 tax year and $7,000 for the 2023 tax year — they can deduct the full amount of their contribution from their taxable income.
That said, you are not eligible to claim your IRA deduction if you are:
- Single and covered by a workplace retirement account and your modified adjusted gross income (MAGI) is more than $83,000 for tax year 2023 ($87,000 or more for tax year 2024)
- Married filing jointly and covered by a work 401(k) plan and your MAGI is more than $136,000 for tax year 2023 ( more than $143,000 for tax year 2024)
- Married, only your spouse is covered by a work 401(k) plan, and your MAGI is more than $228,000 for tax year 2023 ($240,000 or more for tax year 2024).
It’s worth noting that you may claim a partial deduction, depending on your income if you are:
- Single and covered by a workplace retirement account and your adjusted gross income is more than $73,000 and less than $83,000 for tax year 2023 (more than $77,000 and less than $87,000 for tax year 2024)
- Married filing jointly and covered by a work 401(k) plan and your MAGI is more than $116,000 and less than $136,000 for tax year 2023 (more than $123,000 and less than $143,000 for tax year 2024)
- Married, only your spouse is covered by a work 401(k) plan, and your MAGI is more than $218,000 and less than $228,000 for tax year 2023 (more than $230,000 and less than $240,000 for tax year 2024).
401(k), 403(b), and other non-Roth workplace retirement plans work in a similar way (contributions to Roth IRAs are not tax deductible). For the 2023 tax year, the contribution maximum for a 401(k) is $22,500 with an additional $7,500 catchup contribution for employees 50 and older. For tax year 2024, the contribution maximum is $23,000 with an additional $7,500 catchup contribution for employees 50 and older. A person under 50 who contributes the full amount in 2023 could then deduct $22,500 from their taxable income ($23,000 in 2024), potentially lowering their tax bracket.
One common source of confusion: The tax deduction for an IRA will reduce the amount a person owes in federal and state income taxes, but will not circumvent payroll taxes, which fund Social Security and Medicare. Also known as Federal Insurance Contributions Act (FICA) taxes, these are assessed on a person’s gross income. Both the employer and the employee pay FICA taxes at a rate of 7.65% each.
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Traditional IRA, 401(k), and other non-Roth retirement accounts are deemed “tax-deferred.” Money that enters into one of these accounts is deducted from an eligible person’s total income tax bill. In this way, qualifying individuals do not pay income taxes on that invested income until later.
Because these taxes are simply deferred until a later time, the money in the account is usually taxed when it’s withdrawn.
Here’s an example of this: Having reached retirement age, a person chooses to withdraw $30,000 per year from a traditional IRA plan. As far as the IRS is concerned, this withdrawal is taxable income. The traditional IRA money will be taxed as the income.
So, what’s the point of deferring taxes? Generally speaking, people may be in a higher marginal tax bracket as a working person than they are as a retired person. Therefore, the idea is to defer taxes until a time when an individual may pay proportionally less in taxes.
Tax Brackets and IRA Deductions
Income tax brackets can work in a stair-step fashion. Each bracket reveals what a person owes at that level of income. Still, when a person is “in” a certain tax bracket, they do not pay that tax rate on their entire income.
For instance, in 2023, single filers pay a 12% federal income tax rate for the income earned between $11,001 and $44,725. Then, the tax rate “steps up,” and they pay a 22% tax on the income earned that falls in the range of $44,726 and $95,375. Even if a person is a high-earner and “in” the 37% tax bracket, they still pay the lower rates on their lower levels of income.
Why is this worth noting? Because tax deductions reduce a person’s taxable income at their highest marginal rate (their highest “stair-step”). Using 2023 tax rates, a person with $70,000 in taxable income would be taxed like this:
- 10% up to $11,000 ($59,000 remaining)
- 12% up to $44,725 ($14,275 remaining)
- 22% on the remaining $14,275
However, if that same person contributes the maximum to their tax-deferred retirement account, they would be taxed 22% on the top amount minus what’s deductible. In other words, they wouldn’t be taxed 22% on the full $14,275.
401(k) Withdrawals and Taxation
Now, let’s compare that with the taxation on a $30,000 withdrawal from a 401(k). Assuming 2023 income tax rates, a $12,000 withdrawal would be taxed at a 10% rate up to $11,000 and then a 12% rate for the remaining $19,000.
Taxes are assessed at a person’s “effective,” or average, tax rate. This is another reason that some folks prefer to defer their taxes until later, when they can pay a hypothetically lower effective tax rate on their withdrawals, rather than taxes at their highest marginal rate.
But, here’s why it’s not so simple: All of the above assumes that income tax rates remain the same over time. And, income tax rates (and eligible deductions) can change with federal legislation.
Still, plenty of earners opt to reduce their tax bill at their highest rate in the current year — and a tax deduction via an eligible retirement contribution can do just that.
For individual tax questions, it’s a good idea to consult a tax professional with questions about specific scenarios.
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Simply put, there are no tax deductions for Roth retirement accounts. Both Roth IRA and Roth 401(k) account contributions are not tax-deductible.
The trade-off is that Roth money is not taxed when it is withdrawn in retirement, as is the case with tax-deferred accounts like a 401(k) and traditional IRA. In fact, this is the primary difference between Roth and non-Roth retirement accounts. With Roth accounts, taxes are already paid on money that is contributed, whereas income taxes on a non-Roth 401k are deferred until later.
So, then, what are some advantages of a Roth retirement account? All retirement accounts provide an additional type of tax benefit as compared to a non-retirement investment account: There are no taxes on interest or capital gains, which is money earned via the sale of an investment.
Someone might choose a Roth over a tax-deferred retirement account because they prefer to pay the income taxes up front, instead of in retirement. For example, imagine a person who earned $30,000 this year. They pay a relatively low income tax rate, so they simply may prefer to pay the income taxes now. That way, the taxes are potentially less of a burden come retirement age.
Not everyone qualifies for a Roth IRA. There are limits to how much a person can earn. For a single filer, the ability to contribute to a Roth IRA for tax year 2023 begins to phase out when a person earns more than $138,00 ($146,000 for tax year 2024), and is completely phased out at an income level of $153,000 in 2023 ($161,000 for tax year 2024). For a person that is married and filing jointly, the phase-out begins at $218,000 in 2023 ($230,000 for tax year 2024), ending at $228,000 in 2023 ($240,000 for 2024).
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The maximum amount a person is able to deduct from their taxes by contributing to a retirement account may correspond to an account’s contribution limits.
Here’s how much money can be put into an IRA for the 2023 tax year:
- Traditional IRA: $6,500 ($7,500 if age 50 or older), deductibility depends on whether the person is covered by a workplace retirement plan
- 401(k): $22,500 (additional $7,500 if age 50 or older)
- 403(b): $22,500 (additional $7,500 if age 50 or older)
- 457(b): $22,500 (additional $7,500 if age 50 or older)
- Thrift Savings Plan (TSP): $22,500 (additional $7,500 if age 50 or older)
- Simple IRA or 401(K): $15,500 (additional $3,500 if age 50 or older)
- SEP IRA: The lower of 25% of an employee’s income, or $66,000
- Solo 401(k): Either $22,500 or up to 100% of total earned income as employee, additional opportunity to contribute as the employer
Here are the maximum contributions for the 2024 tax year:
- Traditional IRA: $7,000 ($8,000 if age 50 or older), deductibility depends on whether the person is covered by a workplace retirement plan
- 401(k): $23,000 (additional $7,500 if age 50 or older)
- 403(b): $23,000 (additional $7,500 if age 50 or older)
- 457(b): $23,000 (additional $7,500 if age 50 or older)
- Thrift Savings Plan (TSP): $23,000 (additional $7,500 if age 50 or older)
- SEP IRA: The lower of 25% of an employee’s income, or $69,000
- Simple IRA or 401(K): $16,000 (additional $3,500 if age 50 or older)
The above lists are only meant as a guide and do not take into account all factors that could impact contribution or deduction limits — such as catch-up contributions. Anyone with questions about what accounts they qualify for should consult a tax professional.
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Different types of retirement accounts come with distinct tax benefits and, for eligible investors, IRA tax deductions. Opening a retirement account and contributing to certain tax-deferred accounts may affect how much a person owes in income taxes in a given year. Roth accounts may provide tax-free withdrawals later on.
This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.
Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.
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