Traditional vs. Roth IRA

Individual Retirement Accounts (IRAs) are tax-advantaged savings vehicles designed to encourage retirement savings. The two main types—Traditional and Roth IRAs—have fundamentally different tax treatments that impact contribution deductibility, growth taxation, and distribution rules.

2024 IRA Contribution Limits

For the 2024 tax year (tested on EA exams May 2025 - February 2026):

Key Contribution Rules

• Combined limit: Total contributions to ALL Traditional and Roth IRAs cannot exceed the annual limit
• Earned income requirement: Contributions are limited to the lesser of the limit OR your taxable compensation
• Spousal IRA: A non-working spouse can contribute if the couple files jointly and the working spouse has sufficient earned income
• Contribution deadline: April 15 of the following year (no extensions)

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Traditional IRA

Tax Treatment

• Contributions: May be fully deductible, partially deductible, or non-deductible (depending on income and employer plan coverage)
• Growth: Tax-deferred (no current taxation on earnings)
• Distributions: Fully taxable as ordinary income (except return of non-deductible contributions)

Deductibility Rules: Covered by Employer Plan

If you are covered by an employer retirement plan (401(k), 403(b), pension, etc.), the deduction phases out based on MAGI:

Deductibility Rules: Spouse Covered by Employer Plan

If you are NOT covered by an employer plan, but your spouse IS covered:

If neither spouse is covered by an employer plan: Full deduction allowed regardless of income.

Non-Deductible Contributions & Form 8606

When Traditional IRA contributions are not fully deductible, taxpayers may still make non-deductible contributions:

• Must file Form 8606 to track basis (after-tax amounts)
• Creates a "basis" in the IRA to avoid double taxation on distributions
• Distributions are prorated between taxable (earnings + deductible contributions) and non-taxable (basis) portions
• Pro rata rule: Cannot withdraw only non-deductible amounts first

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Roth IRA

Tax Treatment

• Contributions: Always made with after-tax dollars (never deductible)
• Growth: Tax-free
• Qualified distributions: Completely tax-free (contributions AND earnings)

2024 MAGI Phase-Outs for Contributions

Qualified Distributions (Tax-Free)

For a Roth distribution to be qualified (completely tax-free), TWO requirements must be met:

1. 5-Year Rule: The first Roth IRA contribution was made at least 5 tax years ago (starts January 1 of the contribution year)

2. Qualifying Event:

   • Age 59½ or older
   • Death
   • Disability
   • First-time home purchase (up to $10,000 lifetime)

Non-Qualified Distributions

If both requirements are NOT met:

• Contributions: Always withdrawn tax-free and penalty-free (since already taxed)
• Earnings: Subject to income tax AND 10% early withdrawal penalty (if under 59½)

No RMDs During Owner's Lifetime

Unlike Traditional IRAs, Roth IRAs have no Required Minimum Distributions (RMDs) during the owner's lifetime. This makes Roth IRAs excellent wealth transfer vehicles.

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Comparison: Traditional vs. Roth IRA

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Roth Conversions

A Roth conversion moves funds from a Traditional IRA (or other pre-tax retirement account) to a Roth IRA:

• Taxable event: The converted amount is included in gross income
• No income limits: Anyone can convert regardless of MAGI
• Separate 5-year rule: Each conversion has its own 5-year holding period for penalty-free withdrawal of converted amounts (before age 59½)
• No 10% penalty: Conversions are not subject to the 10% early withdrawal penalty (but the converted amount is taxable)

Backdoor Roth Strategy

For high-income taxpayers who exceed Roth IRA contribution limits:

1. Contribute to a non-deductible Traditional IRA ($7,000 or $8,000)
2. Convert to Roth IRA shortly after
3. Report on Form 8606

Important: The pro rata rule applies if you have existing pre-tax Traditional IRA balances. To avoid taxation on conversion, ensure no pre-tax IRA balances exist on December 31 of the conversion year.

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EA Exam Tips

Remember the phase-out ranges: Single Roth ($146K-$161K), MFJ Roth ($230K-$240K), Single Traditional w/plan ($77K-$87K), MFJ Traditional w/plan ($123K-$143K)

5-Year Rule + Qualifying Event: Both must be met for Roth earnings to be tax-free

Contribution limits are combined: $7,000/$8,000 total across ALL IRAs

Form 8606: Required for non-deductible Traditional IRA contributions and Roth conversions

No RMDs for Roth: Major advantage for estate planning and wealth accumulation