Taxes are due by April 18th, 2022. There is still time left to make your contribution to IRAs for the 2021 tax year!
Astute investors know that saving for retirement can be a great way to plan for the future. Here’s how the future is more unpredictable now more than ever:
- Life expectancy has increased compared to the generations of our grandparents and parents
- Only 10% of us will have pensions
- We’ll probably receive less in social security funds than previous generations
- Future healthcare is a potentially expensive unknown
IRA accounts offer a good medium to build wealth for your future. When you invest in an IRA, you earn interest on the money, which gets added to your principal – then you earn interest on interest. This way your money compounds over time.
Traditional and Roth IRA are the most commonly utilized retirement vehicles. They have different eligibility criteria and benefits. Traditional IRAs are funded with pre-tax dollars, which can lower your annual tax bill now.* On the other hand, a Roth IRA is funded with post-tax dollars—so your investment earnings can grow tax-free.**
Here is a quick cheat sheet to help you choose the best IRA for yourself.
Who can open an IRA account:
Anyone with taxable income can contribute to a traditional or Roth IRA. If you don’t have taxable earnings, consider opening online savings or interest earnings checking accounts. Married spouses who are employed and have taxable earnings may also open an account for their partners.
If you are a freelancer, an entrepreneur or self-employed, you may contribute to a SEP(Simplified Employee Pension) IRA or SIMPLE(Savings Incentive Match Plan for Employee) IRA. SEP IRA’s contribution limits are higher than those for traditional IRAs.
Traditional vs. Roth IRAs: What is the difference?
The main difference comes down to taxes and when you pay them. A Roth IRA is funded with post-tax dollars—so after age 59 ½, withdrawals of the money you put in (contributions) are penalty and tax-free. Prior to age 59 ½, withdrawals from the interest and/or earnings are subject to income tax and a 10% penalty. All earnings are tax-free at age 59½ or older, assuming your first contribution was more than 5 years prior. A Traditional IRA is funded with pre-tax dollars, which can lower your annual tax burden now. However, withdrawals made after age 59 ½ are subject to income tax (but no penalty fee). Withdrawals made prior to age 59 ½ are generally subject to income tax and a 10% penalty.
Contribution Limits :
Please refer to the Traditional IRA and Roth IRA tables for contribution limits. If you are married and filing jointly and MAGI (Modified Adjusted Gross Income) is less than $198k then you may contribute up to $6k ($7k if age > 50years) to Roth IRA, if your MAGI lies between $198k and $208k then you can contribute a reduced amount.
If you are single/ head of household or filing separately then you can also contribute $6k ($7k if age > 50years) to Roth IRA if your MAGI is less than $125k.
In the case of Traditional IRA, if either one ( you or your spouse) is covered under a Retirement Plan (401k, 403b, or others) at work, the deduction may be reduced or eliminated.
If you are not covered by a plan at work and you are single then irrespective of your MAGI you are eligible for full deduction up to the amount of your contribution limit, whereas if you are covered by a plan then you can contribute only if your MAGI is less than $105k, or a reduced amount if it ranges between $105k to $205k.
If your spouse is covered under a plan at work then you can contribute if MAGI is less than $197k or a reduced amount if it is within the range of $197k to $207k.If you are covered by a plan at work and you are single/head of household then the MAGI has to be less than $ 66k to contribute to a traditional IRA, or in between $ 66k to $76k for deduction of a reduced amount.
You can have both a traditional and a Roth IRA at the same time. But your total contribution to both can’t exceed the contribution limits: $6,000, or $7,000 for people who are 50 or older.
Which IRA is better?
The answer depends on your personal situation. If you earn a high salary, a traditional IRA may be better, because income limits probably prevent you from contributing to a Roth and you may reduce your taxable earnings by contributing to a Traditional IRA.
You should also consider your current and potential future tax brackets. If you estimate your tax bracket at the time of retirement would be lower when you retire, a traditional IRA would reduce your taxable income now and also when you withdraw in the future. Conversely, if you estimate your taxable income at the time of retirement to be higher, you may contribute to a Roth IRA.
|Traditional IRA||Roth IRA|
|Income requirements & Age limit||Must earn taxable income to be eligible; Your income does not limit how much you can contribute, but can limit how much of your contribution you can deduct from taxable income, if you’re covered by a workplace plan, you can contribute to age 701/2||Must earn taxable income to be eligible; Your income may limit how much you can contribute, no age limit to make contributions.|
|Contribution Limits||$6,000, or $7,000 for ages 50 and older in 2021.||$6,000, or $7,000 for ages 50 and older in 2021.|
|Taxability||Tax-deductible contributions and tax-deferred (meaning you have to pay taxes when you withdraw).||Taxable contributions but tax-free withdrawals|
|Withdrawals||Withdrawals made before age 59 ½ are generally subject to income tax and a 10% penalty, with some exceptions. After age 59 ½ you are no longer subject to the penalty.||Withdrawals of contributions are penalty and tax-free. Before age 59 ½, withdrawals of earnings are subject to income tax and a 10% penalty, with some exceptions.|
Once you are pretty sure which IRA is best for you, you can go forward and determine the next course of action with a tax professional, financial advisor who is familiar with your background. You can always take the help of advisors like Plootus to help you make the right decisions
The flowchart above is only for guidance purposes, the limits stated are for the year 2021, don’t forget to check the IRS website for the latest limits, in case you are looking for 2022 limits don’t forget to check our social media page for the same in May ’22.
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Until next time!
Sheikh Nazrana, Sunil Gangwani