Hello, this is Noel Dalmacio, your ultimate CPA at lowermytaxnow.
Today, I will share with you some common IRA tax questions that I usually get from my clients.
Are you ready?
Here’s the first question:
Which retirement account will give you more money when you retire: a traditional IRA or a Roth IRA? Why?
Roth IRA benefits
Roth IRA will usually give you more money when you retire.
Basically, you can get a tax deduction when you contribute to a traditional IRA as long as you meet certain income rules. However, you have to pay taxes when you start taking it out during retirement. Conversely, a Roth IRA contribution is not tax deductible. However, the contributions and earnings will be tax-free when you take it out later. That’s huge!
Also, the Roth IRA has these additional benefits:
- No required minimum distributions (RMD) on your Roth IRA when you reach 70 ½ years old.
- Tax-free transfer to your beneficiaries or heirs when you pass away as long as the account is open for at least 5 years.
- Won’t increase your Social Security tax bill if your total income is $32,000 or less for married people or $25,000 for a single person.
- You are building tax-free wealth.
Here’s the 2nd question:
Does it make sense to have both a traditional IRA and a RothIRA? Why or why not?
Future tax rate
The answer boils down to your future tax rate. If you think your tax rate will be higher in retirement, you want to have a Roth account so that you will have tax-free withdrawals. But if you think tax rate will be lower in retirement, a traditional IRA might make more sense since you will pay lower taxes. To hedge your bets, you can contribute to both traditional IRA and Roth IRA. That way, you can have the best of both worlds and have the flexibility of either taking out taxable or tax-free withdrawals during retirement that would help you manage your tax rates.
Here’s the 3rd question:
If you have a 401(k) or 403(b), does it make sense to have a traditional IRA, too, or does it only make sense to have a Roth IRA?
It depends. You need to go through the income limits and see if you qualify to make a deductible traditional IRA or a Roth IRA contribution.
Traditional IRA Income Limits
If you participate in your employer’s 401(k) or 403(b), the deductibility of the traditional IRA contribution is subject to income limits. For 2018, if you file as single or head of the household, the adjusted gross income (AGI) limit is $63,000 – $73,000. If you file as married, your AGI income limit is $101,000 – $121,000.
If only one spouse participates in the employer’s 401(K), then the AGI income limit is $189,000 – $199,000.
So if your income is below the limit, you can take a full IRA deduction. But if it falls between the range, you can take a partial deduction. But if your income exceeded the limit, you cannot take the traditional IRA deduction.
Roth IRA Income Limits
The Roth IRA income limit does not take into account if you have a 401(K) or 403(b), it’s just based on the adjusted gross income limit. For 2018, if you file as single or head of the household, the adjusted gross income (AGI) limit is $120,000 – $135,000. If you file as married, your AGI income limit is $101,000 – $121,000.
So if your income is below the limit, you can contribute up to $5,500 or $6,500 (if 50 years or older) to a Roth IRA. But if it falls between the range, you can only make a partial contribution. But if your income exceeded the limit, you cannot make any Roth IRA contributions.
Roth IRA Backdoor method strategy
If you did not meet the Roth IRA income limits, you can still fund a Roth IRA by using the Roth IRA backdoor method. You basically contribute to a non-deductible traditional IRA and immediately convert it to a Roth IRA. However, if you have other IRAs, you might have additional taxes when you convert. So watch out!
Here’s the 4th and last question:
Should you contribute to an IRA if you’re afraid you might need the money for something else, like an emergency or a down payment on a house? Why or why not?
Yes. You can still contribute to an IRA. The $10,000 IRA withdrawals are not subject to the 10% penalty if you are using it as a down payment for a home. Lifetime limit is $10,000. However, you might still be subject to tax on the withdrawal amounts depending on the type of IRA that you used. If you took it out from a deductible traditional IRA, then you need to pay income taxes on the withdrawal amount. However, if you took it out from your Roth IRA, the withdrawals are treated as made from this order:
- Regular Roth IRA contributions
- Rollover contributions
- From earnings
That means you can take out withdrawals from regular and rollover ROTH IRA contributions and it will be considered the return of capital and not taxable to the extent of the contribution amounts.
There you go. Those are the more popular IRA tax questions that I usually get from my clients. Hopefully, you learned something new.
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Until then, this is Noel Dalmacio, your ultimate CPA at lowermytaxnow.com.