What to know when comparing Roth, traditional IRAs
Cabernet sauvignon or chardonnay? My tastes run more toward ales and stouts, so trying to pair a wine with dinner can be a bit of a stretch for me.
Since it’s tax time, a lot of folks are going through their own pairing exercise, trying to match the right type of IRA, Roth or traditional, to their situation – and that’s something I do understand. If you’re looking for help on that front, here are some comparison points:
Contribution deadline Your 2012 contributions to both types of IRAs can be made until the April 15 tax-filing deadline. No difference there.
Contribution limits For the 2012 tax year, traditional and Roth IRA limits are the same: $5,000. And if you’re 50 or older you can add an additional $1,000. Keep in mind that the base contribution limit will increase to $5,500 this year, but the catch-up amount for those 50 or older remains $1,000. To make any type of IRA contribution, you must have earned income that matches or exceeds your contribution.
Pretax vs. after-tax A Roth IRA contribution will not help with your current tax return. Roth contributions are “after-tax” and are not deductible, so they don’t reduce your taxable income. On the other hand, a traditional IRA contribution may be deductible and thus may help reduce your tax bill. If neither you nor your spouse participates in a retirement plan at work, your traditional IRA contribution will be fully deductible. But if you or your spouse has an employer plan, things get more complicated.
If you participate in a plan at work, your traditional IRA contribution is fully deductible only if your modified adjusted gross income (MAGI) is less than $58,000 for a single filer and $92,000 for those married filing jointly. If your MAGI exceeds these amounts, your ability to deduct is gradually phased out. No deduction is allowed for single filers with a MAGI greater than $68,000 and for married couples filing jointly with a MAGI greater than $112,000. If you’re not an active participant but your spouse is, you can fully deduct your traditional IRA contribution, provided that your joint income is less than $173,000. If your income is greater than $183,000, you cannot deduct any part of your contribution. But just because you can’t deduct your contribution does not mean you can’t make one; anyone can contribute to a nondeductible traditional IRA regardless of income.
Income limits Unlike the traditional IRA, not everyone can contribute to a Roth. For example, if you’re single and have a MAGI greater than $125,000, or if you’re married, filing jointly, and have a MAGI greater than $183,000, you are not allowed to contribute any amount to a Roth IRA in the 2012 tax year. In addition, you are limited to a partial contribution if you’re single and your MAGI is greater than $110,000, or if you’re married, filing jointly and your MAGI is greater than $173,000.
The back end Beyond deductibility, the biggest difference between the two types of IRAs is how withdrawals are treated. With a traditional IRA, withdrawals are considered ordinary income, meaning they’ll be fully taxable at your income-tax rate at that time. With a Roth IRA, both contributions and earnings are available tax-free after you’ve had the account for at least five years and have attained the age of 59½.
As always, I encourage you to check with your certified public accountant or tax preparer for specific guidance on your situation. While I can’t offer much when it comes to pairing the right wine with your meal, I hope that I’ve helped equip you to get your IRA choice right.
J.J. Montanaro is a certified financial planner for USAA, The American Legion’s preferred provider of financial services. Submit questions for him online. www.legion.org/focusonfinances
This material is for informational purposes. Consider your own financial circumstances carefully before making a decision and consult with your tax, legal or estate planning professional.USAA means United Services Automobile Association and its insurance, banking, investment and other companies. Banks Member FDIC. Investments provided by USAA Investment Management Company and USAA Financial Advisors Inc., both registered broker dealers. USAA Financial Planning Services® refers to financial planning services and financial advice provided by USAA Financial Planning Services Insurance Agency, Inc. (known as USAA Financial Insurance Agency in California), a registered investment adviser and insurance agency and its wholly owned subsidiary, USAA Financial Advisors, Inc., a registered broker dealer. Certified Financial Planner Board of Standards, Inc. owns the certification marks CFP® and Certified Financial Planner TM in the United States, which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.