Individual Retirement Arrangements (IRAs) are foundational tax-advantaged retirement accounts established in the U.S. to help individuals save for the future. IRAs facilitate retirement planning by offering distinct tax benefits, but understanding the rules regarding eligibility, contributions, and withdrawals is crucial for maximizing their financial potential.
Roth vs. Traditional: Tax Benefits and Contribution Limits
The two main types of IRAs are Roth and Traditional, differing primarily in how and when they are taxed.
• Roth IRA: Contributions are made with after-tax income (non-deductible). This structure allows the savings to grow tax-free, and qualified withdrawals of both contributions and earnings in retirement (after age 59½ and meeting a 5-year holding requirement) are also tax-free. Roth IRAs are often preferred by younger investors or those who anticipate being in a higher tax bracket in retirement. Original owners of Roth IRAs are not subject to Required Minimum Distributions (RMDs) during their lifetime.
• Traditional IRA: Contributions may be tax-deductible, reducing current taxable income. Funds grow tax-deferred, meaning withdrawals in retirement are taxed as ordinary income. Traditional IRAs are generally subject to RMD rules after the owner reaches a specified age (which differs based on their birth date).
For the 2025 tax year, the maximum total contribution allowed across all Traditional and Roth IRAs is generally 7,000∗∗forindividualsunderage50,or∗∗8,000 for those age 50 or older. This limit cannot exceed the individual’s taxable compensation for the year.
Navigating Income Limits with the Backdoor Roth
While anyone with earned income can contribute to a traditional IRA, Roth IRA eligibility is limited by Modified Adjusted Gross Income (MAGI). For 2025, married couples filing jointly must generally have MAGI below $236,000 to make a full Roth IRA contribution, and single filers must be below $150,000.
High-income earners who exceed the MAGI limits often utilize the “Backdoor Roth IRA” strategy to access the benefits of tax-free growth. This strategy is commonly known as a specific type of Roth conversion and involves two steps:
1. Making a non-tax-deductible contribution to a Traditional IRA.
2. Immediately converting those funds to a Roth IRA.
It is essential for individuals considering a Backdoor Roth conversion to ensure they have a $0.00 balance in all Traditional IRAs (including SEP or SIMPLE IRAs) by the end of the year to avoid the complex pro-rata rule. The pro-rata rule mandates that a conversion includes both pre-tax and non-deductible (after-tax) money, leading to a portion of the conversion being treated as taxable income if pre-tax assets exist in any traditional IRA.
Business and Self-Employed IRAs
IRAs also offer specialized plans for businesses and the self-employed. These plans allow employers to provide retirement benefits efficiently.
• Simplified Employee Pension (SEP) IRA: This plan provides employers, including the self-employed, with a simplified method to contribute to their employees’ retirement. Only employers can contribute to a SEP IRA. Businesses of any size can offer a SEP IRA, and they offer high contribution limits (up to $69,000 in 2024).
• SIMPLE IRA (Savings Incentive Match Plan for Employees): This plan helps small businesses (those with fewer than 100 employees) establish streamlined retirement accounts. SIMPLE IRAs are distinct because they allow contributions from both the employer and the employee. Employee contributions are capped at a lower limit ($16,000 in 2024), plus an additional catch-up contribution for those age 50 and older.
Choosing the appropriate IRA—whether Roth, Traditional, SEP, or SIMPLE—requires careful consideration of current income, expected tax situation in retirement, and employment status to secure the most favorable tax advantages.
