The IRA and its Place in Retirement

Once you’ve maxed out your employer 401(k) Plan – it’s time to move on to IRAs. There are two kinds – the traditional IRA that has been around for decades, and the ROTH IRA, which has been available since 1998.

The two have a few fundamental differences.

The Traditional IRA is funded with BEFORE-tax dollars and taxed when withdrawn; it is subject to Required Minimum Distributions by age 72 (see the new tax law.)

The ROTH IRA is funded with AFTER-tax dollars and untaxed when withdrawn, no RMD’s required but must have a life of at least five years prior to withdrawal.

Assuming you are eligible for both, which do you pick?

Conventional wisdom says your tax rates are likely higher while you are working, so you want to reduce those taxes now and not in retirement. It also stands to reason that before tax dollars leave more available because if you have already paid the taxes – your amount available to invest has been lessened.
The amount allowed to be invested is the same for both, $6,000 in 2021; $7,000 if you are age 50 or older. The amount also cannot be more than your earnings.

A traditional IRA allows you to contribute more, but not all of it provides a tax break. If you plan to save more, be prepared for some serious number crunching when you are ready to withdraw those funds. The amount of deduction allowed depends on whether you are covered by an employer 401(k) plan and your Modified Adjusted Gross Income. You’ll want to be sure to check the rules on this one – it is dependent on your filing status and taxable income.
Withdrawing money from a traditional IRA before you are eligible also carries a 10% penalty if you have not reached age 59 ½. Withdrawals from a ROTH can be made tax-free up to your contribution level at any time – since you haven’t received a tax benefit yet.