On one of my previous article, I’ve talked about the two types of Â non-employer sponsored retirement plan, which is the Individual Retirement Arrangement also known as IRA: The Traditional IRA and the Roth IRA.
The Roth IRA is fairly new as the plan is only 13 years old (inception is 1998 as a result of the Taxpayers Relief Act of 1997) while the traditional IRA has been around for quite some time.
Although, these two types of IRA differ in many aspects, there are also a few similarities that they share.
Feature Similarities of the Two IRAs
Contributions must be from earned income
Only earned income from employment, self-employment, alimony, combat pay, commissions, etc. qualifies as income for the contributing in the IRA. Unearned income such as interests, pension or annuity, income from a partnership for which you do not provide services that are material income producing factor, Â rental property income, royalties or dividend, and any amounts you exclude from income such as Â foreign earned income or housing cost DO NOT QUALIFY.
In addition, individuals can contribute up to the lesser of $5,000 or your earned income. So if you make $5,000 or more, you can contribute up to $5,000. However, if you only make $3,000, you can only contribute $3,000 even if the maximum IRA contribution is $5,000.
IRA Contributions for Non-working Â Spouse
Generally, you can only contribute to your IRA if you have earned income. However, if your spouse work and you stay at home to take care of the kids, you can still contribute even if you do not have earned income. You can do this if you and your spouse file a joint return and as long as your joint gross income does not exceed the limitations discussed above.
If Â you are saving for a traditional IRA, your full contributions may be deductible without any phase out limitations even if your spouse has a retirement plan at work.
Eligible for Saverâ€™s Credit
Roth IRA and Traditional IRA qualifies you for theÂ Saverâ€™s credit if you are within the IRS income threshold limitations. You can take as much as $1,000 ($2,000 if married joint filers) in credit.
Maximum of $5,000 Combined Contribution for Both Roth and IRA
If you have both an Roth IRA and a Traditional IRA and you are contributing funds to both, the maximum combined contribution that you can make for both accounts is only $5,000. For example, if you already put in $3,000 on the traditional IRA, you can only put in $2,000 on your Roth IRA. You cannot contribute $5,000 in your traditional and $5,000 in your Roth IRA in the same tax year.
Earnings Are Tax Deferred
Another similarity between the two is that the earnings are tax deferred, which means that you do not have to pay taxes on the earnings. As you know, you must pay taxes on any earnings unless the IRS tells you don’t. Well, guess what, the IRS says that you do not have to pay taxes on the earnings of your IRA and this would allow you to invest your money back in on the money that you would otherwise use to pay taxes. This way, your money will grow faster, see the article the Power of Investing in a Tax Deferred Account. However, come retirement age, the tax deferment of a Roth IRA has a distinct difference with the traditional and this will be discussed on the next article.
Income Limitations On How Much You Can Contribute
If make a certain amount of money, your contributions will be phased-out or reduce and this applies to both the traditional IRA and Roth. However, there are differences on the range of the income threshold.