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Choose the Right Retirement Accounts in 3 Simple Steps

If you’re confused by all the tax-advantaged retirement account options you can choose from, it’s time to get clarity and use them to build more wealth for the future. Laura walks you through 3 simple steps to choose the right retirement accounts for your situation. 

By
Laura Adams, MBA,
April 25, 2018
Episode #541
Choose the Right Retirement Accounts in 3 Simple Steps

If you’re confused by all the tax-advantaged retirement account options you can choose from, you’re not alone. While it’s great to have more choices than fewer, it can certainly cause analysis paralysis.

Instead of getting caught in a fog of retirement confusion, it’s time to get clarity. Using one or more retirement accounts to sock away savings on a regular basis is the best way to build wealth for the future.

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In this post, you’ll learn three simple steps to choose the right accounts for your situation. Plus, I’ll answer a couple of questions on this topic that I recently received from podcast listeners.

3 Simple Steps to Choose the Right Retirement Accounts

  1. Know the retirement account restrictions.
  2. Choose your retirement plans.
  3. Choose your retirement tax types.

Let's explore these steps in more detail. 

Step #1: Know the retirement account restrictions.

If you understand a couple of restrictions that the IRS imposes on retirement accounts, you can easily use the process of elimination to select accounts. The only restrictions you need to keep in mind are 1) an income limit for the Roth IRA (Individual Retirement Arrangement) and 2) a deduction limit for the traditional IRA.

What’s the Roth IRA Income Limit?

The Roth IRA is the only retirement account that factors in annual income for eligibility. You’re prohibited from making contributions when your income exceeds certain amounts for your tax filing status.

The Roth IRA is the only retirement account that factors in annual income for eligibility. You’re prohibited from making contributions when your income exceeds certain amounts for your tax filing status.

For 2018, if you file taxes as a single and your modified adjusted gross income (MAGI) is higher than $135,000, you cannot contribute to a Roth IRA. And when you earn from $120,000 to $135,000, you’re in a phase out range, which reduces the amount you can contribute.

If you’re married and file taxes jointly, you cannot contribute to a Roth IRA when your household’s joint MAGI exceeds $199,000. And when you earn anywhere between $189,000 to $199,999, your contribution is reduced.

In other words, when you earn below the phase out ranges for your tax filing status ($120,000 for singles and $189,000 for when you’re married filing jointly), you can max out a Roth IRA. For 2018, you can contribute up to $5,500, or $6,500 if you’re over age 50, if you have at least that amount of earned income for the year.

If your income is in a phase out range, you might be allowed to contribute $4,000 instead of $5,500, for example. To calculate your allowable contribution, there’s a worksheet in IRS Publication 590-A.

But what happens if you open a Roth IRA but have income that rises above the allowable threshold? There’s no downside. You can keep the account, enjoy its tax-free growth, and manage your investments any way you like. You just can’t make any new contributions to a Roth IRA when your income exceeds the annual allowable limit.

Please note that this income limit doesn’t apply to Roth accounts you may be offered at work, such as a Roth 401k or a Roth 403b. You can always contribute to a workplace Roth, no matter how much you earn.

What’s the Traditional IRA Deduction Limit?

Now, let’s cover the second restriction that I mentioned, which is a deduction limit on the traditional IRA.

A major advantage of traditional retirement accounts is getting a tax deduction for contributions. For example, if you earn $50,000 doing freelance work and max out a traditional IRA by contributing $5,500, your taxable income for the year would be reduced to $45,500. The lower your taxable income, the less tax you pay.

But when you or a spouse are covered by a retirement plan at work, your allowable deduction for contributions to a traditional IRA may be reduced or eliminated, depending on how much you or your spouse earn.

When you or a spouse are covered by a retirement plan at work, your allowable deduction for contributions to a traditional IRA may be reduced or eliminated, depending on how much you or your spouse earn.

For 2018, if you file taxes as a single and your MAGI is higher than $73,000, you can contribute to a traditional IRA, but you can’t deduct contributions on your taxes when you also have a workplace retirement plan. And when you earn anywhere between $63,000 to $73,000, you’re in a phase out range, which reduces the amount you can deduct.

If you’re married and file taxes jointly with MAGI more than $121,000, you can’t deduct traditional IRA contributions when you have a workplace plan. And when you earn anywhere between $101,000 to $121,000, the deduction is reduced.

To make this restriction a bit more complicated, if you’re married and don’t have a retirement account at work, but your spouse does, there are also deduction limits. In this situation, if you live with your spouse or file a joint tax return, you can’t deduct traditional IRA contributions if your household MAGI exceeds $199,000. And the phase out range is from $189,000 to $199,000.

Again, this deduction limit doesn’t prevent you from being eligible for a traditional IRA. You can always max one out, but the tax deduction you receive may be reduced or eliminated.

You may be wondering if it’s worth it to make non-deductible contributions to a traditional IRA. They’re not as good as deductible contributions, but you may not have another option if you’re a higher earner.

The good news is that non-deductible contributions to a traditional IRA still grow tax-deferred until you take withdrawals in retirement, giving you substantial tax savings over time.

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