The two main types of individual retirement accounts (IRAs) are traditional IRAs and Roth IRAs. In this video, Brendan discusses the differences between the two and what investors should know about each type of account, including contribution and income limits as well as advantages and disadvantages you may not have considered.
Topics Discussed:
2022 maximum contributions
2022 tax-deductibility income limits for traditional IRAs
2022 contribution income limits Roth IRA
Federal tax treatment of traditional IRA vs. Roth IRA
Traditional IRA tax challenges retirees face
Advantages of a Roth IRA for retirees
Transcript:
Hi, and welcome to another edition of coffee with Brendon. Today's episode, we're going to talk about something that some of you will think is very fundamental. And you already know that and you'll say, oh, I can skip this one. But others, this is a question that you may have always wanted to ask and always, always have a question about but never really found a good answer to it. And it is the difference between what is a Roth IRA, and what is a traditional IRA.
So let's jump right in, I got a little side-by-side chart to show that may help with this. So let's make that a little bit bigger here. And on the left side, you have the traditional IRA. On the right side, you have the Roth IRA. So with both of these and 2022, the maximum that you can put into a 6006 1000, unless you're age 50 year old, older, and then you can make a catch-up contribution of $7,000. Assuming that you actually have the right income thresholds. And so with a Roth IRA, you just cannot make a contribution to a Roth IRA if your income as a single person is over $144,000, and as a married person over $214,000. So I've had a couple clients in the last couple of years where they started making contributions to Roth IRAs. But then, because of a bonus, or something that happened, they actually exceeded those thresholds, and you have to actually pull the money out if that was to happen. So bottom line is 144, and 214. Those are the thresholds where you can not make any additional any contributions period in that tax year to a Roth if you're making that kind of household income. And then it starts phasing out at 129, and 204. But if you have less than 129, as a single person, less than 204, as a as a married person, you can make that six or $7,000 contribution. Now, just bear in mind that if you split this where you say I want to put some money into traditional some money into Roth, it all adds together. So if you did make a contract, if you are making planning on making a contribution to a Roth, it is reduced those 6007 $1,000 Maximum contributions are reduced by any traditional IRA contribution that you make. And vice versa. If you're contributing to a traditional, then the Roth IRA reduces that. So that is contributions to a Roth with a traditional IRA, it's a little bit different.
What it comes down to is, if you do not have any kind of retirement plan at work, whether it's you or your spouse, it really doesn't matter how much money you make, you can still make a traditional IRA, traditional IRA contribution that is deductible. And that's a very important thing. Especially if you're in one of the top tax brackets. But if either one of you or your spouse actually are covered by any kind of retirement plan at work, whether it's a SEP IRA, a 401k, a 403, B, any just about any what they call ERISA type plan, there is a limit to how much money you can actually deduct, and what kind of contribution how deductible your contribution actually is. So, long story short, if we're looking at 2022, if you're making over $78,000, as a single person, and you have a 401k at work, or you're a married person and making over $129,000. And either one of you, your spouse or making haven't had a retirement plan or 401k, for three B at work, your W can make a contribution to your IRA, but it won't be deductible, you won't get a tax deduction for that six or $7,000 that you put into that. And we'll talk about that in a moment why you would still take advantage of a traditional IRA but use nondeductible dollars to do it. So the federal tax treatment is where these two really diverge.
And I half-jokingly say that a traditional IRA is kind of a deal with the devil, whereas the Roth IRA is the opposite. What I mean by that is with a traditional IRA, the investment growth and contribution of the investment growth is tax-deferred. And any contributions that you make are tax deductible, which means that you don't have to pay tax today. You even get a tax deduction today Then over the 1020 and 30 years that you may be contributing to, or you may be, you may have that traditional IRA, you don't pay dividend tax on dividends, you know, pay tax on interest, you don't pay tax on capital gains. So for a long time, you may not have to pay any tax whatsoever on that, but it doesn't go away. And so that's the key. And we talked about this in another coffee with Brendon, with required minimum distributions. At age 72, you do have to take mandatory distributions, and for some, some clients that can really mess with them, because number one, if you're taking out these contributions, and that is considered income, your income could, in some cases, double and maybe even triple, you know, from what you're making, and therefore put you into a different tax bracket.
Furthermore, you know, the tax code is littered with all of these, you know, if you make this much money or that much money, you're not eligible for things, you know, most recently, the COVID stimulus checks were based on what your income was. And so for people that have to take these tax-deductible deduction or withdrawals after age 72, in some, in some cases, disqualify them from receiving any kind of stimulus checks further in after age 72. If you make too much money, your Medicare may go up. So that's the challenge with this is that for a long time, you don't have to pay tax, you think this is great, and even get a tax deduction up front with a traditional IRA. But at age 72, you actually do have to start taking some money out and it could really mess with your with your tax, your tax planning, the Roth IRA.
And the reason why is the opposite of the deal with the devil. So I guess it deal with the angels. It's the exact opposite, you can take as much money out of your Roth IRA, you don't have to take any mandatory withdrawals. And all that money is tax free, doesn't impact your taxes whatsoever. So if you do have one of these rots, you don't get any kind of tax deduction in the in whatever you put in is after-tax money, so no tax deduction, but it all the money that you put in, in a future growth that you have with that Roth IRA is tax free. And so those are pretty, pretty important things. And then the last thing here, you have until tax time to make that contribution. So in 2022, it's April 15, 2023.
So I hope this was helpful, real short and sweet. You know, this is the difference between the two traditional IRA tax-deferred, nontax free tax-deferred, you're kind of kicking the can down the road, Roth IRA, tax-deferred or tax-free. You know, a lot of times I tell clients who have kids that are just starting to litter just starting to make some money at their job that they really should be looking at that Roth IRA. So I would strongly recommend taking a really strong look at the Roth IRA, especially when you're in the lower tax brackets and a tax deduction from the traditional IRA isn't worth as much the Roth IRA for that future tax for tax-free growth is really, really important. So again, hope this was helpful. Hope you have a nice weekend, and I'll see you next time. Thanks.
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