Today, there are millions of people who have a 401(k) or other retirement plan through their workplace. However, there are many others who seek other accounts to fund their retirement years. When looking into retirement accounts, there are several factors to consider, one of the most important of them being taxes. Here are some tips on how to choose a retirement account based on how and when they are taxed.
An individual retirement account, or IRA, is an account that allows an individual to save for retirement with tax-free growth or on a tax deferred basis. A traditional IRA allows you to contribute pre-tax dollars and defer taxes until a withdrawal is made in retirement. It is a great option for those who expect to be in the same or lower tax bracket during retirement. You can contribute up to $6,000 for tax year 2022 and up to $6,500 for tax year 2023. If you are aged 50 or older, you can contribute an additional $1,000 per year.
Traditional IRA Tax Implications
While anyone can open and contribute to a traditional IRA, not everyone can deduct contributions during tax time. The amount you can deduct will depend on two factors: whether you or your spouse contribute to a workplace retirement plan and your income. The following groups do not qualify for a tax deduction:
- Single or head of household filers who are covered by a workplace retirement plan, and who earned more than $78,000 in 2022 or who will earn more than $83.000 in 2023
- Married couples filing jointly who are covered by a workplace retirement plan, and who earned more than $129,000 in 2022 or who will earn more than $136.000 in 2023
- Married couples filing jointly with one spouse covered by a workplace retirement plan, and who earned more than $214,000 in 2022 or who will earn more than $228.000 in 2023
- Married couples filing separately with at least one spouse covered by a workplace retirement plan, and who earned more than $10,000 in 2022 or 2023
Most other groups will be eligible for either a partial or full deduction. As far as distributions go, it’s important to note that you may only withdraw from a traditional IRA when you reach age 59 ½. At that time, you’ll begin paying regular income taxes on withdrawals. If you withdraw before age 59 ½ you may be subject to a 10% early withdrawal penalty, unless the money is used for certain expenses. There are also Required Minimum Distributions (RMDs) beginning at age 72.
A Roth IRA is an account that allows you to contribute after-tax dollars and then withdraw it tax-free in retirement. It’s a great option for individuals who expect to be in a higher tax bracket in the future. The contribution limits are the same as a traditional IRA at $6,000 per year, plus an extra $1,000 if you are age 50 or older. The max contribution for 2023 will be $6,500 per year.
Unlike a traditional IRA, there are income limitations to open an account. Single filers, heads of household, or married couples filing separately who did not live together during the tax year cannot earn more than $144,000 to contribute to a Roth IRA. Married couples filing jointly, and qualifying widow(er)s cannot earn more than $214,000. Married couples filing separately who did live together during the tax year may not earn more than $10,000.
Roth IRA Tax Implications
Since there are no RMDs for Roth IRA accounts, these accounts are typically preferred for those who plan to transfer their wealth to heirs, since it would also transfer the tax benefits. Any distributions taken by heirs will also be tax-free. Additionally, you may withdraw contributions penalty-free, even before retirement. Any earnings withdrawn will be taxed. The last thing to note is that contributions made to a Roth IRA are taxed now, so you may not claim a tax deduction for them during tax time.
Tax Relief for Those with Retirement Savings
Deciding on a retirement account will usually come down to when you want to pay taxes on your savings. With a traditional IRA, taxes will be paid in retirement, while a Roth IRA requires you to pay tax on the contributions now. A traditional IRA account may offer tax breaks now depending on your income while Roth IRA contributions are not tax deductible. Whichever account you choose, it’s important to always be aware of the tax implications of each and your responsibility for each during tax time. Optima Tax Relief can help with your tax debt needs. Give us a call at 800-536-0734 for a free consultation today.