Written by Today, we answer the question, what is the difference between the Traditional IRA and the ROTH IRA? There are three key distinctions we share in this video. The goal is to make sure you not only know the differences, but which one makes the most sense for your retirement needs.
1. Taxes
There are three differences we’re going to talk about today. The first one is the tax implications. If you have a traditional IRA, that means you’re investing your money on tax deferred. Tax deferred means you are not going to pay taxes on the money today. Then, when you retire, you will pay whatever the income tax is at that particular time. Your income tax will depend on your income bracket and the tax rates at the time you retire.
If you believe your tax burden will be higher in the future, then you’re going to lean towards the Roth IRA. The Roth IRA allows you to invest money that has already been taxed. Since you have already paid uncle Sam once, he is not going to bother you as long as you don’t touch your money early. The magic number is 59 1/2. If you don’t touch your ROTH before 59 1/2, you should not have a tax burden in retirement.
2. Contribution limits
The good news is there is no difference between the traditional IRA and the ROTH IRA contribution limits. In both instances, you can invest up to $6,000 per year until the gage of 50. Once you are 50, you have what’s called the “catch up provision”. The catch up provision allows you to invest an additional $1,000 per year.
It’s important to note you cannot put $6,000 into your traditional IRA and another $6,000 into your ROTH IRA. Your Roth IRA and your traditional IRA are seen as the same contribution. Which means their combined contribution in any given year can only be $6,000. So if you contribute $3,000 into your traditional IRA, you can only contribute $3,000 into your ROTH IRA. If you contributed $6,000 into your traditional IRA, then you cannot contribute to your ROTH.
3. Income limits
The traditional IRA does not have any income limits. However, there are limits on how much you can deduct from your taxes. The way your traditional IRA works, you’re contributing your money before it is recognized as income. In most circumstances, this reduces your overall taxable income for the year. For example, if you make $100,000 per year and contribute $6,000 into your traditional IRA. Your taxable income would be lowered to $94,000. Which should lower your overall taxes and you can deduct a portion of it. The amount you can deduct can change based on whether your spouse is working and whether you have access to a company retirement plan.
The ROTH on the other hand does have income limits. In 2022, if you file taxes as a single person, your Modified Adjusted Gross Income (MAGI) must be under $144,000. If you’re married and file jointly, your MAGI must be under $214,000. If you make more than the amounts listed, you are unable to contribute to a ROTH IRA.
There is always a backdoor
There is something called a “Backdoor ROTH”, which I discuss in detail in another post. Long story short, you have the ability to contribute your money into a traditional IRA and then convert that into a ROTH IRA. In case you are wondering, this is completely legal and above board. Keep in mind they alter the tax code all the time, so this option may not always be available.
Bonus
There is also an extra benefit for anyone that’s in a lower income tax bracket. They will be able to get a saver’s credit anytime they contribute to their IRA.
Final thoughts
The difference between the traditional IRA and the ROTH IRA come down to taxes. Do you want to lower your tax burden today and pay taxes in retirement? If so, the traditional IRA is for you. Are you concerned about whether taxes may be higher in the future and want to lock in your lower rates? Then the ROTH IRA is for you. You also have that little thing called income limits to deal with when contributing to the ROTH. The traditional IRA and the ROTH IRA each have benefits that are worth exploring and incorporating into your retirement plan.
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Charles Schwab: 2021-2022 Roth IRA Contribution Limits
[…] you to start taking the money out. Now, if the money was in a ROTH IRA, that is a different story. Your ROTH is an after-tax account; meaning your money has already been taxed. Since it has already been taxed, there are no required […]