What’s good about investing in IRAs?

There are two types of IRAs, traditional IRAs vs. Roth IRAs, both of which are discussed in this Financial Guide. Traditional IRAs defer taxation of investment income, and withdrawals are taxable income except for withdrawals of previously nondeductible contributions. In most cases, however, contributions are deductible. Roth IRAs are subject to many of the same rules as traditional IRAs. Still, there are several differences, the primary one being that contributions are not deductible and are made after tax. As such, qualified distributions are generally tax-free.

Traditional IRAs vs. Roth IRAs

Can anyone have a traditional IRA?

If you have income from wages or self-employment income, you can contribute up to $6,500 in 2023. As such, IRAs are available even to children who meet these conditions. Individuals aged 50 and older can contribute an additional $1,000 for a total of $7,500 in 2023.

Can my stay-at-home spouse have an IRA?

Yes. Contributions of $6,500 for each spouse are allowed in 2023 if the couple’s wages or self-employment earnings are $13,000 or more. If less, the contribution amount cannot exceed your or your spouse’s taxable compensation for the year.

What makes Roth IRAs so special?

Roth IRAs offer the following advantages:

• If they qualify, withdrawals are completely exempt from income tax, unlike all other retirement plans.
• Converting traditional IRAs into Roth IRAs can quickly build up a Roth IRA account, but there is a tax cost.
• Since there is no age requirement for withdrawals from a Roth IRA, more money can be left in an account and passed on to heirs than is allowed under other plans.

Can anyone have a Roth IRA?

Not everyone can have a Roth IRA. The following conditions apply:

• You can’t contribute to a Roth IRA for a year with income (AGI) above $153,000 if single or $228,000 on a joint return in 2023 ($144,000 and $214,000, respectively, in 2022).
• It would help if you had earnings from personal services (at least $6,500 or more) to make the (maximum) contribution, although an additional contribution of $1,000 is allowed for individuals aged 50 and over.

Can I set up a Roth IRA for my spouse?

Yes, subject to the income conditions above, contributions of $6,500 each are allowed if the couple’s earnings are at least $13,000 in 2023 ($14,000 if only one of you is age 50 or older or $15,000 if both of you are age 50 or older). Each spouse can contribute up to the current limit; however, the combined total of your contributions can’t be more than the taxable compensation reported on your joint return.

Can I set up a Roth IRA for my child?

Yes, for a child with personal service earnings and subject to the other income conditions.

What’s the downside to Roth IRAs?

The following is a brief list of negative issues regarding Roth IRAs:

• Roth IRA contributions are not tax-deductible. There’s never a deduction for Roth IRA contributions.
• To build a sizable Roth IRA fund, you must convert a traditional IRA (or, after 2007, funds from an employer plan). Conversions are taxable.

Under the new tax reform law, for taxable years beginning after December 31, 2017, if a contribution to a regular IRA has been converted into a contribution to a Roth IRA, it can no longer be converted back into a contribution to a regular IRA. This provision prevents a taxpayer from using recharacterization to unwind a Roth conversion

What can I do if I convert to a Roth IRA and my income exceeds $100,000?

Starting in 2010, the income limit was permanently removed for tax years. Anyone, even those with high incomes, can convert from a traditional IRA to a Roth IRA.

What if my Roth IRA assets fall in value after conversion?

When you convert from a traditional IRA to a Roth IRA, you pay taxes on the value of your account as of the conversion date. If your account loses value and is worth less, you’ll end up paying taxes on the money you no longer have.

Say you convert $50,000 in a traditional IRA to a Roth IRA, and the value drops to $35,000. If you didn’t make any nondeductible contributions, the taxable distribution would be $50,000, which would be the amount you would be paying taxes on. However, now your account is only worth $35,000. By re-characterizing the account, you can avoid paying taxes on the money you no longer have ($50,000). You’ll be back to a traditional IRA, but the account is now worth only $35,000.

Prior to 2018, the IRS allowed you “re-characterize” the account back to a traditional IRA, essentially putting you right back where you were – at least tax-wise. However, tax reform legislation passed in 2017 repealed this special rule, and recharacterizations are no longer permitted.

How are my heirs taxed on inherited Roth IRA wealth?

Your heirs are taxed as follows:

• No tax paid on withdrawals as long as the funds have been in the Roth IRA for at least five years.
• Starting in 2020 (SECURE Act), an heir inheriting a Roth IRA must withdraw the funds within ten (10) years after the account owner’s death (some exceptions apply). Heirs with Roth IRAs inherited before 2020 can spread the withdrawal over their life, continuing the tax shelter for amounts not withdrawn.
• Estate tax treatment is the same as for traditional IRAs.

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