9.1 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.

2025 IRA Contribution Limits

For the 2025 tax year (tested on the 2026-2027 EA SEE, Jul 1, 2026 – Feb 28, 2027):

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, 2026 for 2025 contributions (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 (2025)

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 (2025)

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)

2025 MAGI Phase-Outs for Roth 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 59-1/2 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 59-1/2)

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. Roth 401(k) accounts are also exempt from lifetime RMDs starting 2024 under SECURE 2.0.

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Comparison: Traditional vs. Roth IRA

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Roth Conversions and the Backdoor Roth

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 59-1/2)
• No 10% penalty on the conversion itself, although the converted amount is fully taxable

2025 status: Congress did NOT close the backdoor-Roth loophole through 2025. The strategy remains available, and OBBBA did not modify it.

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 for 2025)
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 the converted earnings, ensure no pre-tax IRA balances exist on December 31 of the conversion year.

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Saver's Credit (Retirement Savings Contributions Credit) — 2025 AGI Caps

Low- and moderate-income taxpayers who contribute to an IRA or employer plan may qualify for the Saver's Credit:

The credit is 50%, 20%, or 10% of up to $2,000 contributed ($4,000 MFJ), depending on AGI tier.

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EA Exam Tips

Memorize the 2025 phase-out ranges: Single Roth $150K-$165K; MFJ Roth $236K-$246K; Single Traditional w/plan $79K-$89K; MFJ Traditional w/plan $126K-$146K; MFJ spouse-only-covered $236K-$246K.

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 (unchanged from 2024).

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

No RMDs for Roth IRAs (lifetime): Major advantage for estate planning and wealth accumulation.

OBBBA Senior Bonus Deduction (2025-2028): Taxpayers age 65+ get an additional $6,000 above-the-line-style deduction (phase-out begins MAGI $75K Single / $150K MFJ; MFS not eligible). This stacks on the existing $2,000 (Single/HoH) / $1,600 (MFJ each spouse) age-65 additional standard deduction and is relevant for retired IRA distribution planning.