Enacted at the end of 2022, the Secure 2.0 law has made traditional and Roth IRAs more advantageous for many taxpayers. Looking to build a tax-favored retirement through IRAs?Let's look at the basic rules and the recent changes that could affect you this tax season.
Traditional IRAs - The Basics
Traditional IRAs are available to individuals under the age of 70½ with earned income. They typically offer a wide range of investment options including stocks, bonds, and mutual funds. There is currently no age limit for making regular contributions to a traditional or Roth IRA if you have compensation income. Individuals under the age of 50 can contribute up to $7,000 in 2024 ($6,500 in 2023) and $8,000 in 2024 ($7,500 in 2023) for individuals over the age of 50. All earnings on your IRA investments grow tax deferred which means you don't need to pay taxes on your investments until you withdraw money. If withdrawals are made before the age of 59½, they may be subject to a 10% early withdrawal penalty, unless an exception applies.
Traditional IRAs can be rolled over or transferred to another traditional IRA or qualified retirement plan without incurring taxes or penalties if it is done properly and within the allowed time frames. They can be converted to Roth IRAs, which involves paying taxes on the converted amount but allows for tax-free withdrawals in retirement.
Roth IRAs - The Basics
Annual Roth contributions can be made up to the amount allowed as a contribution to a traditional IRA, reduced by the amount you contribute for the year to non-Roth IRAs. Annual contributions to a Roth IRA work similarly to traditional IRAs.
One key difference - Roth IRA contributions aren’t tax deductible. However, the earnings are tax deferred and unlike a traditional IRA, withdrawals are tax-free with a few exceptions. Pay outs from Roth IRAs must occur after five years from the date in which you make your first contribution. Also, payouts are tax free, up to $10,000, as a result of a first-time buyer expense, death or disability, or you reach 59½ years old.
"Tax Deductible" Contributions
You can make an annual deductible contribution to a traditional IRA if you (and your spouse) aren’t active participants in employer-sponsored retirement plans - regardless of income level. If you (or your spouse) are active participants in an employer plan and your modified adjusted gross income (MAGI) doesn’t exceed a certain level based on filing status, you can make a deductible contribution as well.
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When you make a deductible contribution to a traditional IRA, you can claim the deduction on your income tax return (Form 1040 or 1040A) for the tax year in which the contribution was made.
Again, deductible IRA contributions can reduce your current tax bill, and earnings are tax deferred. However, withdrawals are taxed in full (and subject to a 10% penalty if taken before age 59½, unless one of several exceptions apply). You can make an annual nondeductible IRA contribution without regard to employer plan coverage and your MAGI. The earnings in a nondeductible IRA are still tax-deferred but taxed when distributed (and subject to a 10% penalty if taken early, unless an exception applies).
Nondeductible contributions aren’t taxed when withdrawn. If you’ve made deductible and nondeductible IRA contributions, a portion of each distribution is treated as if it is coming from nontaxable IRA contributions while the rest is taxed.
It's recommended to consult with your VAAS Tax Consultant or financial professional to determine your specific eligibility for deductible contributions to a traditional or Roth IRA based on your individual circumstances. Need to understand the exceptions to the rules? We can help with that. Schedule your free 30-min consultation today to understand your tax deductions and get started filing your tax returns.