Seeds and Harvest, Basics of Traditional and Roth IRAs

With 2020 in full swing, now is a great time for you to brush up on your knowledge of IRAs. In addition, this can serve as a reminder to review your personal IRA’s status in light of the basic IRA contribution and distribution rules as seen below.

Of course, Individual Retirement Arrangements (IRAs) are IRS (Internal Revenue Service) approved methods of sheltering assets from certain taxes, and can be a crucial component to many retirement plans.

IRAs are quite popular because taxes can take a significant bite out of your finances and many seek to optimize their income and assets such that they maximize their tax-advantaged arrangements.

In light of history, tax avoidance is arguably more American than baseball and apple pie.

Tax advantaged arrangements are typically part of what I call a “Subjective Spectrum.” To translate, the term means that each person or family has a different situation (subjective) and there is a range from the least tax-advantaged account/assets, to the most tax-advantaged assets/accounts (a spectrum.)

Regarding the LEAST tax-advantaged; your “non-qualified” assets, namely many individual and joint savings accounts, other non-qualified brokerage and mutual fund accounts, CDs, interest bearing accounts, among others. These usually produce taxable income each year. (By the way, you can fill these “taxable” account types with investments that have tax advantages, such as many municipal bonds, but I’m referring here to the nature of the accounts themselves.)

On the other end of the spectrum, typically the MOST tax-advantaged accounts/assets are items that can defer taxes or potentially eliminate certain taxes altogether.  This includes Health Savings Accounts (HSA), Roth IRAs, life insurance and annuities, IRC Sec. 529 accounts for higher education, tax-free municipal bonds, and charitable arrangements. In the middle of the spectrum; friends like our qualified dividends, Traditional IRAs, real estate investments, and oil and gas ventures, among others.

[For the curious readers, Trusts may occupy differing places along the spectrum, but more on those another time.]

Nevertheless, as the initial waves of the Baby Boomer generation retires, as well as an increased burden and self-reliance on younger workers to save for their retirement, there is heightened focus on comprehensive retirement plans that seek to provide for financial security by utilizing tax-advantaged arrangements.

Many financial planners agree that holistic retirement plans include some sort of employer-sponsored retirement plan, which can also be tax-advantaged, such as a pension plan or a 401(k) or Roth 401(k) (or another of the numbered or lettered employer arrangements that you may have) but it should also include your own personal savings plan, part of which can be one or many Individual Retirement Arrangements (IRAs).

There are two major types of personal IRAs that the IRS makes available, Roth and Traditional. Different IRAs apply to different circumstances in your career and your financial plan, and whether or not they are sourced through an employer relationship. IRAs can be extremely nuanced, and at the end of the day, the advice of a financial professional with a broad array of knowledge and experience who can tie together multiple professions is crucial in navigating the landscape.

It’s been said that with a Traditional IRA, you don’t pay taxes on the seeds, but on the harvest. With a Roth IRA, the seeds are taxed, and not the harvest.

Generally, with a Traditional IRA:

  • You don’t pay taxes on your contributions from your taxable compensation until the time you withdraw from your IRA account
  • You can contribute up to $6000 a year in 2020 if you are under 50 years old
  • An over age 50 “catch-up” provision allows one to contribute an extra $1000/ year
  • The ability to contribute and deduct contributions from your taxes depends on your filing status (single, married filing jointly etc.), your adjusted gross income (there are phase-outs), and whether you’re considered an “active participant” in some other retirement arrangement(s)
  • Keep in mind that an IRA is not an asset or investment itself, but rather, the arrangement which assets may be purchased within
  • For more information on IRA contributions, see IRS Publication 590-A.

One of the updates from the SECURE Act of 2019 for 2020 moving forward is that you CAN make Traditional IRA contributions even after reaching the required minimum distribution (RMD) age, which has been increased to 72 years old. If you are at or near age 70.5 in 2019 or 2020, please seek the advice of a CPA or advisor because of the nuances related to the change in law, including those related to the CARES Act of 2020 due to COVID-19, which provides the option to skip RMDs for 2020, among other provisions. The idea is that withdrawals are made from the Traditional IRA after you are no longer earning as high an income as you were during your working years, thus, the income produced from a Traditional IRA is likely taxed at a lower tax rate. However, that is not always the case, and taxes are subject to legislative changes.

For those IRAs owners in their 70s or older, regarding required minimum distributions (RMDs,) remember to aggregate your traditional IRAs and take the correctly calculated distributions (typically by 12/31 of the year after the first year of RMDs) as they may be subject to a 50% IRS excise tax. Here is a sample calculator from Fidelity.

Importantly, if you are, or were a beneficiary of an IRA, or an administrator to estate with an IRA, of any age, please know that your loved one’s IRA, or the assets from the “inherited IRA” or “beneficiary designated IRA” that you may have set up, may also be subject to required distributions that could be subject to a significant tax penalty if not taken by deadlines for those distributions. This area of the IRA rules is highly nuanced and hinges on named beneficiaries and spousal status. As such, you should review IRS Publication 529-B carefully, or contact an experienced financial professional or tax advisor immediately if you have questions.

Back on track, if you must access the contributions to a Traditional IRA early, another drawback is non-qualified withdrawals made prior to age 59½ will likely be treated as ordinary income and assessed a 10 percent penalty. However, there are certain withdrawals you can make from a Traditional IRA without penalties, see IRS publication referenced above for details.

With the Roth IRA, generally:

  • Contributions are made with after-tax dollars (non-deductible from income)
  • The contribution limits and “catch-up” provisions are the same as Traditional IRAs, and the limits aggregate across all IRAs (both Traditional or Roth – so if you have both types, you can’t double your contribution amount)
  • Earnings from a Roth IRA will NOT be taxed when you make qualified distributions, provided you have reached age 59 ½ and have held the account at least five years
  • There are no age limits on contributions
  • There are no required minimum distributions, so the assets in a Roth IRA can be kept in the shelter for longer

What the IRS giveth, they can taketh away.

Restrictions apply to contributions into Roth IRAs. For 2020, if you are married and file a joint tax return, you must make less than $196,000 (MAGI) to contribute up to the maximum contribution, with a phase-out until $206,000. If you are single, head of household or married filing separately and not living with a spouse, the phase-out is from $124,000 to $139,000. Basically, if you are under $124,000, you should be able to contribute the maximum for 2020.

The Roth IRA gets a lot of attention, and rightfully so; it is an excellent arrangement for many. Today, however, we won’t delve into the more esoteric topics such as conversions, and other strategies, but please know that the Traditional IRA and Roth IRA share many great qualities, such as their tax advantages and certain liability and bankruptcy protections. Plus, as you may know, contributions can be made after the end of the year for the prior year’s contribution (normally April 15th, or that year’s tax filing deadline, NOT including extensions) so this allows for post-December 31st planning and arranging of funds.

At the end of the day, even the slightest differences in your situation can make a significant impact in deciding what is best for you. It is always wise to consult with a knowledgeable professional with significant experience in helping others like you.

Joseph M. Prisco Jr, JD, CFP® is the founder of Advocacy Financial, LLC. He helps clients manage and optimize their financial and estate planning affairs. For more information, or to consult with Mr. Prisco, call 888-787-4590 or write to him at