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Understanding the tax advantages of IRAs

what is the tax advantage of an IRA
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You have until the tax filing deadline, without extensions, to make IRA contributions for the previous year. For 2020, the deadline is April 15, 2021.

IRA contribution limits and deadlines

There are two types of IRAs traditional and Roth and they each come with distinct tax advantages and eligibility rules.2

No matter what you choose (traditional, Roth, or a combination of the two), your total contribution limit is the same. For 2020, you're limited to a maximum of $6,0003 or $7,000 if you are between the ages of 50 or older by the end of the year. Thanks to the SECURE Act, signed into law in December 2019, there is no longer an upper age limit on IRA contributions,4 provided you are still working.

The deadline to make IRA contributions for the 2020 tax year is April 15, 2021 the same day your 2020 taxes are due.

 

Traditional IRA

Contributions to a traditional IRA may be tax-deductible for the year the contribution is made. Anyone who has earned income or has a spouse with earned income can contribute to an IRA. However, there are limits on how much you can contribute pre-tax.

If you or your spouse is covered by an employer-sponsored retirement plan, such as a 401(k), your deduction may be reduced, possibly all the way to zero, based on your income.5 For single filers in 2020, your deduction may be reduced if your modified adjusted gross income (MAGI) is above $65,000. The deduction is eliminated entirely once your MAGI reaches $75,000. For married couples filing jointly, the deduction is phased out between $104,000 and $124,000.

Starting at age 72 (or age 70 if you turned 70 prior to July 1, 2019) you would typically be required to start taking required minimum distributions6 from a traditional IRA. (It used to be 70 for everyone before the SECURE Act.) In addition, the CARES Act waived required minimum distributions for 2020.7

If you are eligible to make a tax-deductible contribution to a Traditional IRA, this is a great choice to make for tax savings and to help you save more for retirement.

 

Roth IRA

Contributions to a Roth IRA are not deductible in the year they are made, but withdrawals including interest and other earnings are typically tax-free in retirement.

Contributions to a Roth IRA aren't affected by participation in an employer-sponsored retirement plan. However, your ability to make Roth contributions may be limited based on your income.8 For 2020, single taxpayers can make a full contribution to a Roth if their MAGI is below $124,000. Eligibility phases out above that number, with no Roth contributions allowed once MAGI reaches $139,000. Married taxpayers filing jointly can make the full contribution to a Roth if their MAGI is below $196,000. Eligibility phases out once a married couple's MAGI exceeds $196,000, with no Roth IRA contributions allowed once it reaches $206,000.

Distributions from a Roth IRA are tax-free in retirement, and no distributions are required during your lifetime.

Contributing to a Roth IRA is a great choice if you anticipate that your tax rate in retirement will be more than it is today or if you're only eligible for a post-tax contribution to a Traditional IRA.

No matter which type of IRA you choose, the earlier you start saving for retirement, the better off you'll be.

Important disclosure information

This content is general in nature and does not constitute legal, tax, accounting, financial or investment advice. You are encouraged to consult with competent legal, tax, accounting, financial or investment professionals based on your specific circumstances. We do not make any warranties as to accuracy or completeness of this information, do not endorse any third-party companies, products, or services described here, and take no liability for your use of this information.

  1. Investment Company Institute, "Retirement Assets Total $33.1 Trillion in Third Quarter 2020," published December 16, 2020, accessed January 6, 2021. Back
  2. Internal Revenue Service, Traditional and Roth IRAs," updated November 10, 2020, accessed November 24, 2020. Back
  3. IRS.gov, "Retirement Topics - IRA Contribution Limits," updated December 4, 2020. Accessed December 9, 2020. Back
  4. Daniel Kurt, "What Is the SECURE Act and How Could It Affect Your Retirement?" Investopedia. Updated March 31, 2020, accessed December 9, 2020. Back
  5. IRS.gov, 2020 IRA Contribution and Deduction Limits Effect of Modified AGI on Deductible Contributions If You ARE Covered by a Retirement Plan at Work," updated November 2, 2020. Accessed December 9, 2020. Back
  6. IRS.gov, "Retirement Topics Required Minimum Distributions (RMDs)," updated September 23, 2020. Accessed December 9, 2020. Back
  7. IRS.gov, "IRS: Seniors, retirees not required to take distributions from retirement accounts this year under new law," published July 17, 2020. Accessed December 9, 2020. Back
  8. IRS.gov, "IRS: Seniors, retirees not required to take distributions from retirement accounts this year under new law," published July 17, 2020. Accessed December 9, 2020. Back