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Saving for retirement is very important, we all know that. One important tool in helping you save for retirement is an Individual Retirement Account (“IRA”). In this post we will first discuss what an IRA is. Second, we will discuss who’s able to open a traditional and Roth IRAs. Third we will discuss the difference between a traditional IRA and a Roth IRA. Lastly, we will discuss how and where to open an IRA.
What is an IRA?
An IRA is an account that allows an individual to save for retirement with tax-free growth or on a tax-deferred basis. There are two main types of IRAs, traditional and Roth. Traditional IRAs are tax-deferred vehicles while Roth IRAs are tax-free growth vehicles. For 2020 and 2021 the total contributions you make each year to all of your traditional IRAs and Roth IRAs can’t be more than:
- $6,000 ($7,000 if you’re age 50 or older), or
- If less, your taxable compensation for the year.
Are you eligible for a traditional tax-deductible IRA or Roth IRA?
Traditional IRA
If neither you nor your spouse is covered by an employer’s qualified retirement plan, you are eligible to make tax-deductible contributions to a Traditional IRA no matter what your modified adjusted gross income (“MAGI”). If you are covered by another qualified retirement plan at work (401(k), 403(b)) your deductibility will be reduced when your MAGI reaches a certain limit depending on filing status.
Single or Head of Household
| MAGI | Deduction limit eligibility |
| $61,000 or less | Full deduction up to limit |
| More than $61,000, but less than $71,000. | Partial deduction |
| $71,000 or more | No deduction |
Married Filing Jointly or Qualifying Widower
| MAGI | Deduction limit eligibility |
| $98,000 or less | Full deduction up to limit |
| More than $98,000, but less than $118,000. | Partial deduction |
| $118,000 or more | No deduction |
Married Filing Separate
| MAGI | Deduction limit eligibility |
| Less than $10,00 | Partial deduction |
| $10,000 or more | No deduction |
Roth IRA
Income levels are more liberal for the Roth IRA, and you can establish and contribute to a Roth IRA even if you already participate in an employer-sponsored retirement plan. Roth IRA contributions, unlike traditional contributions, are not deductible against your taxable income. Amounts you can contribute to a Roth IRA is dependent upon your filing status and MAGI.
Single, Head of Household, or Married Filing Separately
| MAGI | Deduction limit eligibility |
| Less than $116,000 | Full amount up to the contribution limit |
| $116,000 or more, but less than $131,000 | Reduced contribution |
| $131,000 or more | Zero |
Married Filing Jointly or Qualifying Widower
| MAGI | Deduction limit eligibility |
| Less than $183,000 | Full amount up to the contribution limit |
| $183,000 or more, but less than $193,000 | Reduced contribution |
| $193,000 or more | Zero |
Married Filing Separate
| MAGI | Deduction limit eligibility |
| Less than $10,000 | Reduced contribution |
| $10,000 or more | Zero |
Traditional IRA vs Roth IRA?
Eligibility requirements vary between the traditional and Roth IRA (see limitations above). But what if you are eligible for both? How do you choose? In order to arrive at this you have to weigh the unique aspect of each IRA type against one another.
Traditional IRA
Assuming you’re eligible, contributions will grow tax-deferred, which means you won’t pay taxes until you withdraw funds, presumably at retirement. Taxes will be on both your contributions and the earnings. If you are not eligible for the deduction, your contributions and earnings will still benefit from the tax-deferred growth, which is why having an IRA is still a good option for anyone saving for retirement.
Roth IRA
Roth IRAs, unlike traditional IRAs, don’t offer a tax deduction when you make a contribution. However the power of the Roth IRA is that the earnings are always tax-free. This tax-free growth and the fact that Roth IRAs are not subject to required minimum distributions after age 70½ are their major advantages.
Excess Contributions
There are additional taxes on IRAs if you:
- Contribute more than the contribution limit
- Make a regular IRA contribution for 2019, or earlier, to a traditional IRA at age 70½ or older
- Make an improper rollover contribution to an IRA.
Excess contributions are taxed at 6% per year for each year the excess amount remains in the IRA. The tax can’t be more than 6% of the combined value of all your IRAs as of the end of the tax year. To avoid the tax, you must withdraw:
- The excess contribution from your IRA by the due date of your individual income tax return (including extensions); and
- Any income earned on the excess contribution.
Whether you would benefit more from a traditional IRA vs a Roth IRA depends on various variables such as age of retirement, when you plan on taking distributions, your tax bracket now, and what your estimated tax bracket may be in the future. This analysis also requires looking at your total investment picture.
How and Where to Open an IRA?
1. How much assistance do you want
If you want to choose and manage your investments, you’ll need an online broker. Here you’ll open an account and buy and sell investments yourself over time. If you would like an automated way to manage your investments, consider a robo-advisor. A robo-advisor will choose low-cost funds and rebalance your portfolio, keeping it in line with your investing preferences and timeline for a fraction of the cost of hiring a financial advisor.
2. Choose where to open your IRA
Once you have chosen your investing style, the next step is choosing a provider that fits your preference.
| Hands-on investor | Hands-off investor |
| Should have 0 commissions now | 0.40% or less management fee |
| Wide selection of no-transaction-fee mutual funds and commission-free exchange-traded funds | Automatic rebalancing and portfolio allocation (target date funds) |
3. Open an account
Actual steps will vary by provider, but it is an easy process. In general, you’ll head to the provider’s website, choose the type of iRA you want to open (traditional or Roth) and fill in personal details such as your social security number, date of birth, contact information, and employment information. See below for a few options.
| IRA Providers | Style | Commissions | Promotion | Acct. Min. | Learn More |
 | Hands-on | $0 per trade | Up to $600 | $0 | Open an account. |
 | Hands-on | $0 per trade | None | $0 | Open an account. |
 | Hands-off | 0.25% mgmt fee | 1 yr. free mgmt fee | $0 | Open an account. |
 | Hands-on | $0 per trade | None | $0 | Open an account. |
| * Fidelity Go | Hands-off | Up to 0.35% mgmt fee | None | $0 | Open an account. |
Conclusion
IRAs can be a useful and efficient way to save up for retirement. Which IRA is best for you will be based on your individual facts and circumstances. For further information regarding IRAs you can visit the IRS website. For a side-by-side comparison of the Traditional and Roth IRAs, see this IRS chart. For more information on rollovers see the IRS Rollover Chart. Note, the items discussed have mainly been around federal income tax purposes. Note that states may treat items differently.
Disclaimer: The information provided herein is intended solely for informational purposes and no person(s) or other third-party may rely upon it as financial, tax, or legal advice or use it for any other purposes. As a result, Royal Financial, and any affiliates, assume no responsibility whatsoever to readers, or any other persons for that matter, as a result of the information contained herein.