ST. CROIX INSIGHTS

First off, pay now or pay later—that is the question. Ordinarily, when we discuss the difference, most individuals generally point out the fact that they’ll be in a lower tax bracket come retirement. However, I’m 99% confident that this is probably not the case for most of us.

Remember, our government needs and wants your money. In short, a host of factors will ultimately decide your tax rate at retirement, the two biggest of which are health and lifestyle in your golden years.

Although we can run the math a thousand ways, the biggest question to ask is: Do you want all of your income in retirement taxed? The answer is often no.

Here’s a list of some of the differences between two of the most common retirement accounts: the Roth IRA and the Traditional IRA account. If you have specific questions, please don’t hesitate to contact us.

The Difference Between a Roth IRA and Traditional IRA

Roth IRA

• Eligibility: Individuals must have taxable compensation, or a spouse with earned income if filing jointly. Contributions are not subject to age requirements.
• Tax Treatment: Contributions are not tax-deductible and are subject to modified adjusted gross income (MAGI) limitations.
• Contribution Limits for 2024 and 2025:
  • Individuals under age 50 can contribute up to $7,000.
  • Individuals aged 50 and older can contribute up to $8,000, including a $1,000 catch-up contribution.
  • Note: The total contribution to all IRAs (Roth and Traditional) cannot exceed these limits.
• Income Limits for 2024:
  • Single Filers:
    • Full contribution allowed if MAGI is less than $146,000.
    • Contribution limit phases out between $146,000 and $161,000.
    • No contribution allowed if MAGI is $161,000 or more. Time to consider Backdoor Roth.
  • Married Filing Jointly:
    • Full contribution allowed if MAGI is less than $230,000.
    • Contribution limit phases out between $230,000 and $240,000.
    • No contribution allowed if MAGI is $240,000 or more. Time to consider Backdoor Roth.
• Income Limits for 2025:
  • Single Filers:
    • Full contribution allowed if MAGI is less than $150,000.
    • Contribution limit phases out between $150,000 and $165,000.
    • No contribution allowed if MAGI is $165,000 or more. Time to consider Backdoor Roth.
  • Married Filing Jointly:
    • Full contribution allowed if MAGI is less than $236,000.
    • Contribution limit phases out between $236,000 and $246,000.
• No contribution allowed if MAGI is $246,000 or more. Time to consider Backdoor Roth.
• Distributions:
  • No required minimum distributions (RMDs) during the account holder’s lifetime.
  • Qualifying distributions are tax-free, offering significant tax advantages during retirement.
• Best Practices:
  • To maximize tax benefits, keep funds in the account for at least five years and wait until age 59½ before taking distributions.
  • Withdrawals before meeting these criteria may incur a 10% tax on earnings.

Note: Be aware of the 5-year tax rule for Roth plans.

Once you open a Roth IRA, you need to wait five years after your first contribution to withdraw funds tax-free. January 1 of the first year you contribute begins the five-year countdown. For example, if you make your first contribution on March 1, 2025 the five-taxable-year period starts January 1, 2025 and ends December 31, 2030.

Failing to meet the five-year rule means earnings could be subject to income taxes and possibly a 10% early withdrawal penalty if other qualifying criteria (like age 59½) aren’t met.

This rule applies for conversions as well. If you convert funds from a Traditional IRA to a Roth IRA, a separate five-year period applies for the converted amount. Each conversion has its own five-year clock, starting on January 1 of the year the conversion is made.

Traditional IRA

• Eligibility: Individuals must have earned income, or a spouse with earned income if filing jointly.
• Tax Treatment:
  • Contributions are generally tax-deductible.
  • Deductibility phases out if the contributor or spouse participates in an employer-sponsored retirement plan and the household income exceeds IRS thresholds.
• Contribution Limits for 2024 and 2025:
  • Individuals under age 50 can contribute up to $7,000.
  • Individuals aged 50 and older can contribute up to $8,000, including a $1,000 catch-up contribution.
• Distributions:
  • Withdrawals before age 59½ are subject to a 10% early withdrawal penalty unless meeting specific exceptions, such as death, disability, qualifying education expenses, medical expenses, or first-time home purchases.
  • Required minimum distributions (RMDs) must begin at age 73, regardless of whether you need the funds, potentially impacting your tax situation.

Choosing Between a Roth and Traditional IRA

Deciding between a Roth IRA and a Traditional IRA depends on your current financial situation, expected tax rate in retirement, and long-term goals. Consulting with a skilled financial planner can help you make the best decisions for your situation. Call St. Croix Advisors at (651) 337-1919 or (877) 393-1919 or email info@stcroixadvisors.com for more information.