Individual Retirement Accounts, or IRAs, are a playing an increasingly important role for Americans as they ready for retirement. According to the Employee Benefit Research Institute (EBRI), in 2015, there were 25.8 million IRA accounts owned by 20.6 million unique individuals. Altogether, we're talking about $2.46 trillion in assets based on data compiled through the end of 2013. By comparison, the EBRI had only estimated a little over $1 trillion in assets held by IRAs just a few years prior. This goes to show just how quickly IRAs are gaining in popularity.
Traditional IRA vs. Roth IRA: What's the difference?
When choosing an IRA, consumers have a big decision to make: to go with a Traditional IRA, or stick to a Roth IRA. Each has its own advantages and disadvantages.
The biggest draw of a Traditional IRA is the upfront tax benefits for most Americans. Money contributed to a Traditional IRA is considered pre-tax, meaning it can reduce your taxable income. Additionally, money invested in a Traditional IRA is allowed to grow on a tax-deferred basis. As long as you don't make any unqualified withdrawals (which could necessitate you paying ordinary income taxes and a 10% penalty to boot), your investments can continue to grow unimpeded until you begin making eligible withdrawals during retirement.
The notable downsides of a Traditional IRA are twofold. First, you will wind up paying tax on the money you withdraw during retirement, and it's possible that this income, which counts toward your annual adjusted gross income, could push you into a higher tax bracket. The last thing seniors want during their golden years is to be saddled with an unwanted tax bill, or to have to hand back their hard-earned retirement money to Uncle Sam. Also, you're required to begin taking a required minimum distribution (RMD) each year from your Traditional IRA beginning in the year you turn 70 and 1/2 years old.
Your other option is the Roth IRA. The big allure of a Roth IRA is that money contributed can grow completely tax-free for life. Contributed money is considered after-tax, meaning there is no upfront tax benefit. The real benefit can be seen multiple years or decades later, when time and compounding have worked their magic on your nest egg and you're able to make withdrawals without paying a cent in tax or having it count toward your annual adjusted gross income. You'll also find added flexibility with a Roth IRA since there are no RMDs or age limits as to when you must stop contributing.
While downsides tend to be few and far between with a Roth, one notable disadvantage is that there are income limits on individuals and couples who can contribute. There are still back doors into a Roth IRA for upper-income earners, but you'll need to take a few extra steps.
One similarity shared by both savvy retirement plans are the contribution limits of $5,500 for persons aged 49 and under, and $6,500 for people ages 50 and up for 2016 and 2017.
Three IRA changes in 2017 you'll want to know
As we ready to turn the page to a new year, we should also be aware of some key changes being made to IRAs in 2017.
1. Traditional IRA income limits to qualify for deduction rose
To begin with, Traditional IRA income limits in order to qualify for the aforementioned upfront tax deduction are on the rise in 2017. It should be noted that these income limits pertain to workers and couples where a retirement plan is offered at a place of employment. If no retirement plan options are offered for an individual or either spouse, such as a 401(k), then you can take an upfront tax deduction regardless of your income.
For single filers and those who are married and filing jointly, the IRA deduction income limits are rising by $1,000 in 2017. Any adjusted gross income (AGI) below the following ranges would entitle you to a full deduction, while any amount above the upper end of these ranges excludes you from taking a Traditional IRA tax deduction. If your income falls within the income limit ranges, you're allowed a partial deduction.
In instances where you have no retirement plan offered at your work, but your spouse does, and you file jointly, there's a $2,000 increase in the IRA income limits, as seen below.
2. Roth IRA phase-out and exclusion limits increased
Secondly, the phase-out and exclusionary income limits to contribute to a Roth IRA are being adjusted slightly higher as well. Single-filers will see the phase-out range increase by $1,000, while persons who are married and filing jointly will see their range jump by $2,000. Just as with the Traditional IRA income limits, if your AGI falls below these ranges, you're free to make a full contribution. Meanwhile, if your income is higher than these AG limits, you're excluded from contributing to a Roth IRA. If your AGI falls in between the listed range, you may make a partial contribution.
3. A modest increase in the Savers Credit income limits
Finally, there was a modest uptick in the income limits for low-to-moderate income individuals and families who are able to take advantage of the Savers Credit. This is a tax credit available to low-and-middle-income folks who make retirement plan contributions (e.g., to an IRA, 401(k), 403(b), 457 plans, and so on).
In 2016, the upper bound of the credit was $30,750 for single filers, $46,125 for head of household, and $61,500 for joint filers. In 2017, the new upper bound is $31,000 for single filers, $46,500 for head of household, and $62,000 for couples filing jointly. Though the credit dips to just 10% once you near those upper bounds (its three tiers are 10%, 20%, and 50% of your contribution based on your AGI), it's still a nice incentive for lower- and middle-income folks who are diligently saving for their futures.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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