Five questions to help decide which IRA is right for you
You may be wondering if you should include an individual retirement account (IRA) in your retirement plan. IRAs generally come with tax advantages, and you can set them up on your own because they don’t necessarily have to be associated with an employer. There are a few different kinds of IRAs—traditional and Roth being the most common—and it’s important to understand how each one can affect your taxes both today and in retirement. Consider these five questions when determining what kind of IRA might be right for you.
IRAs offer benefits that may be able to help you save for retirement, even if you also have a retirement plan, such as a 401(k), through your employer. More than 40% of Americans have IRAs, and many also have an employer-sponsored plan. With traditional IRAs, contributions are made with pretax dollars and not taxed until a distribution is taken. With Roth IRAs, contributions are made with after-tax dollars and distributions are generally tax free.
1 What are the differences between traditional and Roth IRAs?
Feature |
Traditional |
Roth |
How contributions are taxed |
Pretax—Contributions can be deductible in the year they're made to the account.1 |
After tax—Contributions are taxed before being made to the account. |
How withdrawals are taxed |
Withdrawals, which include contributions and any earnings, are taxed as ordinary income when withdrawn.2 |
Contributions can always be taken out tax free. Earnings on investments are tax free and penalty free for withdrawals taken five years after being held in the Roth, provided the withdrawal is made after age 59½ or due to death/disability. Also, up to $10,000 in earnings are tax free for first-time home purchase. Otherwise, earnings are taxed as ordinary income and if under age 59½ subject to an early distribution penalty of 10%. |
Maximum annual contribution for 20233 |
Lesser of $6,500 or 100% of compensation ($7,500 if age 50 or older) |
Lesser of $6,500 or 100% of compensation ($7,500 if age 50 or older) |
Criteria to save in an IRA |
Generally, anyone can contribute; to deduct contributions from taxable income, certain criteria must be met based on access to an employer-sponsored retirement plan and income level. |
To contribute to a Roth IRA, income must fall below certain income thresholds. |
How required minimum distribution (RMD) rules apply |
RMD rules apply after you turn 73. RMDs are the minimum amounts you must withdraw from your retirement accounts each year. |
RMD rules do not apply during your lifetime. RMD rules will apply to your beneficiary. |
2 Can you have both traditional and Roth IRAs?
You can contribute to both types in the same year providing you meet eligibility requirements. When considering if and how much to contribute, make sure you don't exceed the combined annual contribution limit set by the IRS (see question 5 below). Contributing to both can help provide taxable and tax-free withdrawal options in retirement, providing you with some tax savings both today and during retirement.
3 Why consider a traditional IRA?
If you expect to be in a lower tax bracket during retirement, a traditional IRA might make the most financial sense. By contributing pretax today while in a higher tax bracket, you’ll potentially pay taxes at a lower rate when withdrawing the money during retirement.
4 Why consider a Roth IRA?
If you expect to have a higher income in retirement than while you’re working, then a Roth IRA might be right for you. Because you don’t receive a tax deduction for the money contributed to a Roth IRA today, the withdrawals you take during retirement are generally tax free (see above chart for more details). Earnings, however, may be subject to taxation and an early 10% penalty tax if the withdrawal is made before the Roth IRA account has been in existence for five years and you reach age 59½ (or death or disability).
5 Do IRS limits apply across all IRAs or per IRA?
Although there aren’t restrictions on how many IRAs you can have, the IRS does set annual contribution limits. The maximum annual contribution isn’t per account, it’s the total that can be contributed across all traditional and Roth IRA accounts. For example, you could contribute $3,250 to a traditional IRA and $3,250 to a Roth IRA, not $6,500 to each.
If you’re rolling money directly from one IRA to another, or from an employer-sponsored plan to an IRA, there’s no limit on either the amount you can roll over (or transfer) or the number of times you can do it in a year. In other words, if the money is going directly from one institution to another, there are generally no limits.
But there are limits on indirect rollovers. An indirect rollover means that you would take money out of a 401(k) or IRA (in a check made payable to you, not your institution) and then put it back into a 401(k) or IRA within 60 days. These are limited to one per 12 months (not per calendar year), and you must also fill in appropriate paperwork.
Decide how IRAs fit into your plan
There are many reasons you might consider an IRA. If you aren’t offered a retirement plan from your employer, you may want to consider opening an IRA as soon as possible to start saving for retirement. Or if you’ve left an employer, you might want to roll over your related 401(k) to a traditional or Roth IRA.4 Adding an IRA to your retirement plan can offer tax benefits and help build your retirement savings.
1 Tax deductibility is based on meeting certain IRS criteria. 2 Withdrawals before the age of 59½ may be subject to an early distribution penalty of 10%. 3 Amounts are evaluated each year and subject to change. Amounts shown are for the 2023 calendar year. 4 Rollovers of non-Roth monies to a Roth IRA result in immediate taxation; taxpayers should discuss with a tax professional to understand the full tax implications.
Important disclosures
The content of this document is for general information only and is believed to be accurate and reliable as of the posting date but may be subject to change. It is not intended to provide investment, tax, plan design, or legal advice (unless otherwise indicated). Please consult your own independent advisor as to any investment, tax, or legal statements made.
Any tax-related discussion contained in this publication, including any attachments, is not intended or written to be used, and cannot be used, for the purpose of avoiding any tax penalties or promoting, marketing, or recommending to any other party any transaction or matter addressed. Please consult your independent legal counsel and/or professional tax advisor regarding any legal or tax issues raised in this publication.
Income-tax rules on how withdrawals are handled may vary from state to state.
In this document, all tax disclosures regarding Roth 401(k) contributions are limited to the federal income-tax code and, in particular, all references to tax-free treatment of qualified distributions are intended to refer to the treatment of such distributions at the federal level only.
Distributions from Roth accounts must be “qualified” for both the contributions and earnings to be treated as tax free. Certain conditions would apply. See your plan document for more details. All references to tax-free treatment of qualified distributions are intended to refer to the treatment of such distributions at the federal level only. You may want to consult a professional tax advisor regarding any tax issues discussed.
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