Roth IRA contributions are funded with after-tax earnings. However, earnings grow tax-free and can be withdrawn tax-free, too, as long as the account is open for 5 years and you're age 59 1/2 or older at the time of distribution.
Meigs notes that Roth earnings never have to be withdrawn, and you can contribute to a Roth as long as you earn money. That's a great help for those who plan to work well past traditional retirement years. On the other hand, withdraw earnings before 59 1/2 and you'll generally pay a 10% penalty on any earnings. You can withdraw your contributions at any time.
However, you may earn too much to fund a Roth, because they're available only to individuals whose modified adjusted gross income doesn't exceed a maximum of $132,000 in 2016. For married couples filing a joint tax return, eligibility requirements top out at $194,000.
If your income disqualifies you from funding a Roth, consider the traditional IRA, which offers its own set of perks.
With a traditional IRA, you may be able to claim a full income-tax deduction for your contributions, as long as you don't have access to a retirement plan at work, such as a 401(k). Single filers who do have access to such a plan can take a full deduction if they earn $61,000 or less, or a partial deduction up to $71,000 in 2016. The income limits are trickier for married couples filing jointly. If you have access to a plan, the limits are $98,000 to $118,000; if your spouse has access to a plan but you do not, the limits are $184,000 to $194,000 for joint filers. Remember: If your employer does not offer a retirement plan, you can get the full tax deduction for traditional IRA contributions regardless of your income.
Even if you can't claim any tax breaks from your traditional IRA, you can make nondeductible contributions to a traditional IRA. And, since 2010, you have the option to convert a traditional IRA to a Roth IRA, regardless of how much you earn.
At a glance: Traditional IRA vs. Roth IRA |
|---|
| Tax deduction for funding the account? | Yes, though income limits apply if you have access to a workplace plan. | No. |
| Required minimum distributions? | Yes, by age 70 1/2. | No. |
| Earnings | Taxed at withdrawal. | Never taxed unless withdrawn early. |
Either way, the traditional IRA lets earnings grow tax-deferred, so you postpone paying income taxes until assets are taken out of the account. That has to begin by the time you're 70 1/2 or you'll face penalties for not taking so-called required minimum distributions. That's also the age when you're prohibited from making additional contributions to the traditional IRA.