Welcome to part two of our three-part series on retirement savings outside of the employer sponsored 401(k) plan. This series may be relevant to you if you are self-employed or are an employee and desire to save additional funds for retirement in a personal account. Before we dive in to part two of this series that focuses on Traditional IRAs, I would encourage you to first check out the series introduction and part one that focused on Roth IRA savings.
What is a Traditional IRA?
Basically, a traditional IRA is an account type that offers you the opportunity for tax-advantaged retirement savings. Traditional IRAs give individuals the opportunity to save in addition to, or in place of, employer sponsored 401(k) type retirement savings. They are an account type in which you are able to buy investments to take advantage of market gains over time to grow your account value.
What are the pros of opening a Traditional IRA?
- Ownership of account at brokerage or bank of your choice
- Flexibility in investment choices
- No income limits on traditional IRA ownership
- Deferral of tax on investment growth and earnings until time of withdrawal
- Avoidance of early withdrawal penalty for some first time homebuyer expenses and certain educated-related expenses
What are the cons of a Traditional IRA?
- 10% penalty and tax on withdrawals before age 59 1/2
- Required minimum distributions must be taken beginning at age 72
- If you have a retirement plan at work, your tax deduction benefit will phase out at higher income levels (see table below)
How is a Traditional IRA different from a Roth IRA?
A traditional IRA is different from a Roth IRA when we look at it from a tax benefit perspective. Contributions to traditional IRAs can be deductible from gross income on the individual tax return in the year of contribution. This simply means that as opposed to the Roth IRA, you receive the tax benefit of contributing to a traditional IRA upfront as you are allowed deductibility of your contributions in the year that they are made. This is much different from the characteristics of a Roth IRA because with those contributions you do not get a deduction at the time of contribution. However, with the Roth IRA, your earnings accumulate tax-free and your qualified withdrawals are tax-free.
Unlike Roth IRA withdrawals which are tax-free, Traditional IRA withdrawals are taxed at the time of withdrawal as ordinary income. This makes them more attractive to someone who feels like they will be in a lower tax bracket during retirement than they are during their working/contributing years.
Also, Roth IRA accounts do not require distributions at age 72 in the same way as Traditional IRAs.
Who can contribute?
Anyone can open and contribute to a Traditional IRA, but not everyone with qualify for tax deductible contributions.
Who can make tax deductible contributions?
See table below for the details on income, contributions, and deductibility.
| Filing Status | 2020 MAGI | Deduction |
| Single or Head of Household | $65,000 or Less | Full Deduction |
| >$65,000 but <$75,000 | Partial Deduction | |
| >$75,000 | No Deduction | |
| Married Filing Jointly | $104,000 or Less | Full Deduction |
| >$104,000 but <$124,000 | Partial Deduction | |
| >$124,000 | No Deduction | |
| Married Filing Jointly | $196,000 or Less | Full Deduction |
| (spouse covered by employer retirement plan) | >$196,000 but <$206,000 | Partial Deduction |
| >$206,000 | No Deduction | |
| Married Filing Separately | <$10,000 | Partial Deduction |
| (you or spouse covered by employer retirement plan) | >$10,000 | No Deduction |
Which choice is best- Roth vs. Traditional
After looking at the characteristics of the Roth IRA is part one of the series, and now diving into Traditional IRA characteristics in part two of the series, we can compare the two based on both short-term and long-term value and tax advantage.
In my opinion, as long as you qualify for a Roth IRA based on the income qualifications, you should utilize that account type before looking at putting money in any other IRA type. You should also be sure that if you have an employer 401(k) plan available to you, that you are at least contributing enough to get your employer match before looking into other IRA types.
Next steps
If you believe that you are ready ramp up your retirement savings through the use of a Roth IRA as discussed in part one, or a traditional IRA as discussed in part two of this series you should speak to a trusted financial advisor, bank, or look into self-managed options that may be right for you.
For more clarification on the tax effects of IRA savings, talk with your CPA. If you do not yet have a relationship with a CPA, feel free to reach out to us at info@bynumcpa.com.
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