Roth and Traditional IRA Contribution Rules

You may have heard this common acronym before, but if not, an IRA is an Individual Retirement Arrangement, and it’s a term used to describe two different types of accounts: Roth and Traditional. Both have tax advantages yet have different rules to be mindful of. For example, earnings in either of these accounts can accumulate tax-free, but depending on your situation they may be taxed at a later date.

You can start either a Traditional or Roth IRA if you receive taxable compensation from the following sources:

While the income sources for both types of IRAs are the same, the differences between the two account types become clear when you start looking at the details.

With a Traditional IRA, the income limit to contribute to all accounts (both Traditional IRAs and Roth IRAs) must be the smaller of:

• Your taxable compensation for the year
• $6,500, the maximum IRA contribution for 2023 or $7,500 if you’re age 50 or older and are making catch-up contributions

These two tests determine how much of your IRA contributions are tax-deductible:

If you’re covered by a company plan, a second test indicates how much of your IRA contribution you can deduct. If you’re an active participant in a company plan, the Traditional IRA deduction for 2023:

If you have contributed to a nondeductible Traditional IRA, keep track of your basis to make sure you don’t pay tax on the money again when you withdraw it.

Basis is usually the combination of nondeductible IRA contributions made and the basis from after-tax amounts in qualified retirement plans rolled over to your Traditional IRA accounts. If so, you’ll need to calculate the taxable portion of any withdrawals.

• You must designate the account as a Roth IRA when you start the account.
• You can’t deduct your contributions to a Roth IRA on your tax return, but your withdrawals, assuming you follow the rules (i.e. make qualified distributions), will be tax free.
• You can make contributions to your Roth IRA regardless of your age, however; you must receive taxable compensation to make contributions.  (Starting in 2020 you can continue to make Traditional IRA contributions as well.)
• You don’t have to take withdrawals starting at any age.
• The balance in your Roth IRA account when you pass generally goes to your heirs tax-free. The account must have been open and contributed to for at least five years.

Roth IRA contribution limits are the same as those for Traditional. We’ll list them here again for reference.

The maximum amount you can contribute to all accounts (both Traditional IRAs and Roth IRAs) must be less than:

• Your taxable compensation for the year
• $6,500, the maximum IRA contribution for 2023 or $7,500 if you’re age 50 or older and are making catch-up contributions

Additionally, in 2023, Roth contributions:

• Begin to phase out when your MAGI reaches $138,000 if you are Single or Head of Household, or $218,000 if Married Filing Jointly
• Is phased out completely when your income is more than $153,000 if you are Single or Head of Household, or $228,000 if Married Filing Jointly
• Married couples Filing Separately can’t make Roth IRA contributions if their MAGI is more than $10,000 and you lived together at any time during the year.
• You can file Married Filing Separately and contribute to a Roth IRA if you didn’t live with your spouse at any time during the year. Your MAGI limits are the same as the Single or Head of Household filing status as mentioned above.

Roth IRA contributions are taxed as normal income because they aren’t deductible. Because your contributions are included in your normal income the year you contribute, you can withdraw your contributions (but not your earnings) tax-free and penalty-free at any point you wish to do so. Rollover contributions are subject to a different set of rules.

There’s no minimum age to participate in an IRA. If your teenage child has compensation from a part-time job, your child can contribute to an IRA up to $6,500 (or their compensation amount if lower).

You can have many IRA accounts and can:

• Contribute to a single Traditional IRA or Roth IRA account each year
• Open a different account each year
• Divide each year’s contribution among several accounts
• Divide your contribution between a Traditional IRA and a Roth IRA, subject to the MAGI limits that apply

However, by having more than one account you might also pay multiple trustees for annual fees or other bookkeeping fees.

No matter how many accounts you have, your total annual contributions can’t be more than the maximum allowable limit. Speak with a financial professional for investment guidance.

You don’t have to keep your IRAs in the same investment types or financial institutions from your contribution date to your retirement date. You can move your money around to take advantage of changes in the market or in your investment philosophy.

However, you must follow certain rules. Some financial institutions might impose penalties if you change investments before the maturity date is up (Ex: CDs and annuities).

Moving money from your Traditional IRA to a Roth IRA is called a conversion. Many people take advantage of this method because you can convert funds from your Traditional IRA to a Roth IRA regardless of income. Take note: Any money in your Traditional IRA that wasn’t previously taxed (contributions and earnings depending on your situation), will be taxed the year you do the conversion to a Roth. Also, once you convert funds from your Traditional IRA to a Roth IRA you can’t change your mind and return the money to your traditional IRA.