One of the most practical ways to save for retirement is to fund an individual retirement account. Many individuals prefer the current deferral of taxes provided by a traditional IRA. However, some persons are not eligible to fund a regular IRA. Individuals ineligible to fund a traditional IRA may be able to fund a Roth IRA instead.
A Roth IRA is not necessarily less desirable than a traditional IRA. In fact, a Roth IRA is sometimes preferred due to its long-term advantages. The main difference between a traditional IRA and a Roth IRA is how income tax is paid on the contributions. The contributions to a traditional IRA are tax-deferred, but the contributions to a Roth IRA are taxed up front.
In later years, all of the distributions from a traditional IRA are taxed. In contrast, all of the distributions from a Roth IRA are usually tax-free, including the earnings. If you are not a participant in an employer-sponsored retirement plan, you may contribute to either type of IRA. However, the traditional IRA option may not be available if you are in a company retirement plan such as a 401(k).
Participation in an employer-sponsored retirement plan
If you are an active participant in an employer's retirement plan, there is an income level at which you become ineligible to deduct a traditional IRA. However, participation in an employer-sponsored plan does not impact your ability to fund a Roth IRA. The primary limitation on your ability to fund a Roth IRA is your level of income.
If you are ineligible for a traditional IRA, you may fully contribute to a Roth IRA if your income is less than the respective thresholds for the following filing statuses:
- $118,000 for single or head of household
- $186,000 for married filing jointly
A reduced Roth IRA contribution may be available if your income is above the threshold. The contribution limit is gradually phased out, and no Roth IRA contribution can be made if your income reaches the following levels:
- $133,000 for single or head of household
- $196,000 for married filing jointly
Effect of an IRA on other retirement plans
A contribution to a traditional or Roth IRA does not affect the contribution limit applicable to your company retirement plan. You can increase the overall contributions to your retirement savings by funding both an IRA and your company plan.
If you are prepared to pay tax on the contribution up front, a Roth IRA can produce tax-free earnings for any number of years. Unlike a traditional IRA, there is no required minimum distribution for a Roth IRA. Contact a financial advisor for information on how to fit the most appropriate type of IRA into your retirement plan.