There are two types of IRAs, traditional IRAs, and 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.
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.
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.
Roth IRAs offer the following advantages:
Not everyone can have a Roth IRA. The following conditions apply:
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.
Yes, for a child with personal service earnings and subject to the other income conditions.
The following is a brief list of negative issues regarding Roth IRAs:
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.
The income limit was permanently removed for tax years starting in 2010. Anyone, even those with high incomes, can convert from a traditional IRA to a Roth IRA.
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.
Your heirs are taxed as follows: