IRA
To be eligible for an IRA, you will need to have earned income. This is from your wages as an employee. If you are self-employed, this would be from your self-employment income.
In the past, there was an age restriction on who can contribute to an IRA. This is no longer the case. If you have the earned income, you can contribute at any age.
The most you can contribute to your IRA in 2024 and 2025 is $7,000. If you are aged 50 or older, you can make an additional ‘catch-up contribution’ of $1,000 for a total of $8,000. If you can, take advantage of this ‘catch-up contribution.’ Every Average Joe is going to need it.
If you have a nonworking spouse (an IRS term, not mine), provided the working spouse earns enough money, the nonworking spouse can also contribute to an IRA. This is what is known as a spousal IRA. For example, both husband and wife are over age 50, only one of them works. Provided the spouse that is working earns at least $16,000, they can both contribute $8,000 each.
The contribution can be made any time during the calendar year. Additionally, the contribution can be made at any time up to the due date of your income tax return which is April 15th.
There may be a limitation on your ability to have a tax-deductible IRA. This is based on whether you, or your spouse, are participating in a qualified retirement plan and your income. The most common qualified retirement plan is an employer sponsored 401(k) plan. Most employers terminated their pension plan years ago. Then many of them adopted the 401(k) plan.
As we have said before, and will continue to say, your 401(k) plan will be the cornerstone of your retirement plan.
Before you contribute to an IRA, the first step is to see if your employer offers a 401(k) plan. If so, check it out. Approximately 52% of private sector employers offer a 401(k) plan. 1)
If your employer offers an employer match, you need to enroll into the 401(k) plan. The good news is that 98% of employers offer an employer match. 2) Contribute at least enough to get the employer match.
Do this before contributing to an IRA.
The reason is you need to get the employer match. Most employers will require you to contribute to the 401(k) plan to get the employer match. This is an employee benefit you need to take advantage of. This is not ‘free money’ as many commentators have described it as. It is an employee benefit. Take advantage of it. You will need everything you can accumulate for retirement as there are 6 Black Swans Easy to See.
Most employer matches will have a vesting schedule. This is where you must remain employed with the company for a period of years. Then the employer matching contribution funds become yours. This could be from three to six years depending on the vesting schedule.
If you are contributing to your 401(k) plan at work, this is a qualified retirement plan. Depending on your income, you may not be entitled to a tax-deductible IRA.
Higher income folks that are in a 401(k) plan can still make an IRA contribution. It is just not tax-deductible. This is known as a nondeductible IRA. As a practical matter, nondeductible IRAs do not make sense. If you have higher income and are eligible, consider a Roth IRA. See below.
If neither you, nor your spouse, are not participants in a qualified plan at work, there is no income limitation to prevent you from having a deductible IRA.
If you, or your spouse is an active participant in a qualified plan at work, like a 401(k) plan, here are the 2024 income limitations based on your modified adjusted gross income.
For single filers with income $77,000 or less, you are entitled to a full deduction. If your income is more than $77,000 and less than $87,000 you can get a partial deduction. If your income is over $87,000, there is no deduction.
Taxpayers that are married filing jointly with income of $123,000 or less, you are entitled to a full deduction. If your income is more than $123,000 and less than $143,000, you can get a partial deduction. If your income is over $143,000, there is no deduction.
The advantage with an IRA is the upfront income tax deduction. The next advantage with an IRA is that the funds grow tax deferred.
There is, however, a day of reckoning. This is when you must begin to take distributions from your IRA and 401(k) plan. This is what is known as your Required Minimum Distribution (RMD). Currently, the RMD starts at age 73. This will increase to age 75 in 2033.
Roth IRA
Like the IRA, you need to have earned income to contribute. The amount that can be contributed to a Roth IRA is the same as an IRA, $7,000 in 2024 and 2025. Also, like the IRA, if you are aged 50 and older, you can make and additional $1,000 ‘catch-up contribution,’ so the total would be $8,000.
You cannot contribute $7,000 (or $8,000) to both an IRA and a Roth IRA. That is the most you can contribute annually to one or the other, or a combination between the two.
Also like the IRA, there is no age limitation in contributing to a Roth IRA. If you have earned income, you can contribute at any age.
There is also an income limitation on contributing to a Roth IRA. In 2024, for single taxpayers if their modified adjusted gross income is less than $146,000, they can contribute up to maximum. With income between $146,000 and $161,000, a reduced contribution is allowed. When income is $161,000 or greater, no contribution can be made.
Married couples filing a joint return can contribute the maximum if their income is less than $230,000. With income between $230,000 and $240,000 a reduced contribution can be made. When income is $240,000 or greater, no contribution can be made.
The significant difference between an IRA and a Roth IRA is that the Roth IRA is not tax deductible. Said differently, you contribute to the Roth IRA with after-tax funds.
The primary advantage to a Roth IRA however is on the back end. If the Roth IRA account has been open for at least five years and you are over age 59 ½, then all the distributions are tax-free.
Another advantage to the Roth IRA is that it is not subject to the RMD rules listed above. There does not need to be any distributions from the Roth IRA account holder or their surviving spouse during their lifetime. Without this requirement, the runway for the Roth IRA to continue to grow tax-free is longer, which is great. RMD’s are required for non-spousal beneficiaries like children and grandchildren.
Roth IRAs are ideal for young folks just beginning in the workforce. Odds are, they are making less now than they will be down the road. A lower income means a lower tax bracket. A lower tax bracket is great for a Roth IRA as it will cost less income tax upfront when making the contribution. The sooner you can start with the tax-free investing of a Roth IRA, the better off you will be.
Action Item
If you need help with the IRA vs. Roth IRA, give us a call at (860) 645-1515 or E-Mail Thomas.scanlon@raymondjames.com.
1) Pensionrights.org – October 23, 2023
2) Myubiquity.com – March 9, 2022
This is original content written by Manchester, CT Financial Advisor, Thomas F. Scanlon, CFP®, CPA.
The information contained in this report does not purport to be a complete description of the securities, markets or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the forgoing material is accurate or complete. Any opinions are those of Thomas F. Scanlon, CFP®, CPA, and not those necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice.
You should discuss your tax or legal matters with the appropriate professional. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Past Performance is not indicative of future results. All investing involves risk. Income from municipal bonds is not subject to state or federal taxes; however, for certain investors, it may be subject to local taxes or the federal alternative minimum tax. Investments in municipal securities may not be appropriate for all investors, particularly those who do not stand to benefits from the tax status of the investment.
401(k) plans are long-term retirement savings vehicles. Withdrawal of pre-tax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59 1/2, may be subject to 10 percent federal tax penalty. Matching contributions from your employer may be subject to a vesting schedule. Please consult with your financial advisor for more information.
Contributions to a traditional IRA may be tax-deductible depending on the taxpayer’s income, tax-filing status, and other factors. Withdrawal of pre-tax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59 1/2, may be subject to a 10 percent federal tax penalty. RMD’s are generally subject to federal income tax and may be subject to state taxes. Consult your tax advisor to assess your situation.