Contributions to IRAs Versus Roth IRAs: Confused No More

There are two personal tax-advantaged ways to save for retirement: an IRA, which may be deductible or nondeductible (“traditional IRA”), and a Roth IRA, which is made with after-tax dollars. These savings options have become very popular. Statistics for 2010 valued investments in individual retirement arrangements at $5 trillion. In that year, 3.5 million taxpayers contributed to IRAs and 5.8 million contributed to Roth IRAs.  Eligible taxpayers have until April 15, 2014, to make contributions for 2013. Contributions can also be made now for 2014. Here are some pointers to clarify confusion about these accounts:

• Contributions to either traditional or Roth IRAs require earned income from a job or self-employment. Some additional income items that can be counted: alimony and combat pay. A contributor who files a joint return can make contributions to a traditional or Roth IRA on behalf of him/herself and the spouse based on the earned income of the contributor (this is called a Kay Bailey Hutchison IRA).
• The annual dollar limit on contributions (e.g., $5,500 for 2013 and 2014), as well as the catch-up contribution amount for those 50 and older ($1,000) applies to IRAs and Roth IRAs in total. Thus, for example, if a 45-year-old contributes $2,000 to a traditional IRA for 2014, the maximum contribution is $3,500 ($5,500 – $2,000).
• Contributions depend on the year you designate for them, as long as the designation is not made after the filing deadline. For example, someone age 58 could contribute a total of $13,000 now: $6,500 for 2013 (assuming it is made no later than April 15, 2013) and $6,500 for 2014.
• Contributions to Roth IRAs can be made whether or not the contributor is covered by a qualified retirement plan. Thus, an employee can add to a 401(k) plan as well as contribute to a Roth IRA. However, income limits on eligibility for a Roth IRA may limit or prevent a contribution. These income eligibility limits, which depend on your filing status, are adjusted annually for inflation.
• Contributions to a traditional IRA by contributors who are active participants in qualified retirement plans (e.g., 401(k) plans; simplified employee pension plans [SEPs]) are tax deductible only if the contributor’s income is below set limits. Again, these income eligibility limits, which depend on your filing status, are adjusted annually for inflation. Contributors who are active participants can make nondeductible contributions without regard to their income.
• Contributions to IRAs or Roth IRAs are not impacted by conversions to Roth IRAs. Thus, conversions can be made in the same year in which a Roth IRA contribution is made.
• Conversions to Roth IRAs have no income limits. Taxpayers can convert any portion of traditional IRAs they choose.
• Contributions to traditional IRAs cannot be made once the contributor reaches age 70¹/₂. Contributions to Roth IRAs have no age limit, so seniors who continue to work can add to their Roth IRAs.

Bottom line: IRAs and Roth IRAs offer significant tax breaks. What’s more, they are a disciplined way to save. If you have a choice between these options, decide which one works better for your situation: an up-front tax deduction for a traditional IRA or the potential for future tax-free income from a Roth IRA.