IRA/ROTH IRA Investments
What Is a Traditional IRA?
A traditional individual retirement account (IRA) allows individuals to direct pre-tax income toward investments that can grow tax-deferred. The IRS assesses no capital gains or dividend income taxes until the beneficiary makes a withdrawal. Individual taxpayers can contribute from qualified earned compensation.
Income thresholds may also apply. Contributions to a traditional IRA may be tax-deductible depending on the taxpayer's income, tax-filing status, and other factors.
How Traditional IRAs Work
Traditional IRAs let individuals contribute pre-tax dollars to a retirement investment account, which can grow tax-deferred until retirement withdrawals occur (at age 59½ or later). Custodians, including commercial banks and retail brokers, hold traditional IRAs and place the invested funds into different investment vehicles according to the account holder’s instruction and based on the offerings available.
Contributions to traditional IRAs are tax-deductible in most cases. For instance, if someone contributes $6,000 to their IRA, they can claim that amount as a deduction on their income tax return and the Internal Revenue Service (IRS) will not apply income tax to those earnings. But when that individual withdraws money from the account during retirement, earnings are taxed at their ordinary income tax rate.
The IRS restricts contributions to a traditional IRA each year, depending on the account holder's age. The contribution limit for savers under 50 years of age is $7,000 in 2024. For people aged 50 and above, higher annual contribution limits apply via a catch-up contribution provision, allowing for an additional $1,000. This means it's a total of $8,000 in 2024.
Roth IRAs
Unlike a traditional IRA, Roth IRA contributions are not tax-deductible, and qualified distributions are tax-free. This means you contribute to a Roth IRA using after-tax dollars, but as the account grows, you do not face any taxes on investment gains. Because you paid taxes on your contributions, you can withdraw them, penalty-free, at any time; however, you cannot withdraw earnings until age 59½ without being subject to the 10% early-withdrawal penalty.
When you reach age 59½, you can withdraw from the account without incurring any income taxes on your withdrawals. Roth IRAs do not have RMDs. If you don't need the money, you don't have to take it out of your account and worry about penalties for failing to do so. You can also pass the money to your heirs if you don't end up needing to use it.
Roth IRA contributions are the same as traditional IRAs: $7,000 unless you are 50 or older and can qualify for the catch-up contribution, which raises the limit to $8,000 in 2024. The catch is that not everyone qualifies to contribute to a Roth IRA. There are income limitations, with contributions gradually phased out as your MAGI increases.