Retirement

Traditional, Roth, IRAs, and 401(k)s

Retirement rules can look like a collection of account names, contribution limits, age rules, and exceptions. Before we worry about any of those details, start with one question:

When is the money taxed—now or later?

That question gives us the basic difference between Traditional and Roth treatment.

There is one more big idea to keep in mind from the beginning:

With most retirement accounts, the tax does not disappear. We are mainly changing when the tax happens.

Traditional treatment generally gives us the tax benefit earlier and pushes the tax later. Roth treatment generally does the opposite: we pay the tax now so qualified withdrawals can receive the benefit later.

That distinction will become especially useful when we compare retirement accounts with Health Savings Accounts. An HSA can potentially receive favorable treatment going in and coming out when the rules are satisfied. Most retirement accounts make us choose which side gets the tax benefit.

1. Traditional and Roth: when is the tax paid?

At the most basic level, think of the two approaches this way:

Traditional: benefit now, tax later

For our big-picture model, benefit now means you generally get a current deduction or another subtraction from income for the contribution. The exact mechanics depend on the retirement arrangement. Your employer might do the subtraction before the wage amount reaches your tax return, or you might claim the deduction yourself on the return.

Tax later means that when taxable money eventually comes out of the retirement arrangement, the distribution is generally included in income on that later tax return.

In simplified form:

TODAY:  Contribution → current deduction/subtraction from income
LATER:  Taxable withdrawal → included in income

The money inside the account can also grow without the investment earnings being taxed every year as they occur. With Traditional treatment, that growth is generally tax-deferred: tax is postponed until taxable amounts come out later.

Roth: tax now, benefit later

Tax now can be a confusing phrase. It usually does not mean that you put the Roth contribution on a special line of the tax return and pay a separate tax on it.

Instead, it means you generally do not get a current deduction for the contribution. The income you used to make the Roth contribution remains part of the income being taxed now.

Benefit later means that a qualified Roth withdrawal generally is not included in taxable income when you take the money out later.

In simplified form:

TODAY:  Contribution → no current deduction; income stays taxable now
LATER:  Qualified withdrawal → not included in taxable income

Investment earnings also can grow inside the Roth without being taxed every year. If the eventual distribution is qualified, those earnings can come out tax-free as well.

So when you hear Traditional or Roth, do not start with contribution limits or forms. Start with:

When do I get the tax benefit, and when is the money included in taxable income?

2. Traditional and Roth are tax treatments; IRA and 401(k) are arrangements

Once the timing difference makes sense, we can add the account names.

Traditional and Roth describe the general tax treatment.

IRA, 401(k), 403(b), and other plan names describe different retirement arrangements.

That means you can have, for example:

• a Traditional IRA or a Roth IRA;
• a traditional 401(k) or a Roth 401(k);
• and, depending on the plan, similar Traditional/Roth choices in some other retirement arrangements.

An IRA and a 401(k) are also not mutually exclusive. A taxpayer can have a retirement plan at work and also have an IRA. The existence of the workplace plan can affect some IRA tax rules, but it does not mean the taxpayer has to choose one account or the other.

This distinction is useful:

Traditional or Roth   = WHEN the tax benefit occurs
IRA / 401(k) / 403(b) = WHICH retirement arrangement is being used

3. 401(k) plans: the employer usually does the subtraction for you

Suppose Maya earns $60,000 and contributes $5,000 to a traditional 401(k) through payroll.

In a simplified federal income-tax example:

Salary                                   $60,000
Less: Traditional 401(k) contribution     (5,000)
                                         -------
Federal taxable wages                    $55,000

The tax benefit happened through payroll. Maya’s employer knew about the contribution and did the subtraction before reporting her federal taxable wages.

So when Maya prepares her return, she generally starts with the $55,000 wage amount. She does not subtract the same $5,000 again as an IRA-style deduction.

The big idea is:

The employer already did the math for you.

If Maya instead made a Roth 401(k) contribution, she generally would not get that current federal income-tax subtraction. Her contribution would be made with income that remains taxable now, in exchange for favorable treatment of qualified distributions later.

One wrinkle matters: a traditional 401(k) contribution can reduce wages for federal income tax without necessarily reducing wages the same way for Social Security and Medicare taxes. Different taxes can use different tax bases.

401(k) contribution limits are separate—and much higher

A 401(k) also has annual contribution limits, but the employee contribution limit is separate from the IRA limit and is usually much higher.

Traditional 401(k) and Roth 401(k) employee contributions generally share the same employee elective-deferral limit. In other words, choosing both Traditional and Roth inside the 401(k) does not double the employee limit.

Check the current 401(k) contribution limits on IRS.gov.

What about a 403(b)?

A 403(b) is another workplace retirement arrangement that you may encounter, especially with certain public-school and tax-exempt employers. For our purposes here, the important point is that it is another retirement arrangement that can use Traditional or Roth treatment. You do not need to memorize all of its separate rules right now.

4. IRAs: the taxpayer usually handles the deduction on the return

An IRA is an individual retirement arrangement. It is not the same thing as a workplace 401(k).

Suppose Maya earns $60,000 and contributes $5,000 to her own Traditional IRA.

Her employer does not know that she made the IRA contribution, so the employer generally reports her wages without subtracting it.

If the contribution is deductible, the simplified route looks like this:

Wages reported                           $60,000
Less: Deductible Traditional IRA          (5,000)
                                         -------
Income after the deduction               $55,000

Notice that we reached the same simplified $55,000 result as the traditional 401(k) example. The difference is who did the subtraction and where it happened.

That is also a no-double-benefit check. If payroll already reduced the taxable wage amount for a traditional 401(k) contribution, do not subtract that same contribution again on the individual return.

• With the traditional 401(k), the employer generally handled the subtraction through payroll before the wage amount reached the return.
• With the deductible Traditional IRA, the taxpayer generally claims the deduction in arriving at AGI.

You can have both an IRA and a 401(k)

This is important because the names can make the choices sound mutually exclusive.

A taxpayer may participate in a 401(k) at work and contribute to an IRA.

But having a retirement plan at work can affect whether a Traditional IRA contribution is deductible. That is where AGI, MAGI, and phaseouts come back into the picture.

IRA contribution limits: Traditional and Roth share one annual limit

You cannot put an unlimited amount into an IRA just because the account receives favorable tax treatment. Congress places an annual limit on regular IRA contributions.

One especially important rule is that Traditional and Roth IRAs share the same annual IRA contribution limit. Opening both types of IRA does not double the amount you are allowed to contribute.

For example, suppose the annual IRA limit for a taxpayer is $7,500. The taxpayer could contribute:

Traditional IRA contribution             $7,500
Roth IRA contribution                          0
                                           ------
Total IRA contributions                   $7,500

or split the same limit between the two:

Traditional IRA contribution             $4,000
Roth IRA contribution                     3,500
                                           ------
Total IRA contributions                   $7,500

But the taxpayer generally could not contribute $7,500 to the Traditional IRA and another $7,500 to the Roth IRA for the same year.

There is another important distinction:

How much you may contribute and how much you may deduct are separate questions.

A taxpayer may be allowed to make a Traditional IRA contribution even when the current deduction is limited or eliminated. Roth IRA contributions have their own income-based eligibility rules.

Check the current IRA contribution limits on IRS.gov.

How do you actually open an IRA?

The tax rules can make IRAs sound complicated. Actually opening one is usually much easier than understanding all of the tax rules around it.

IRAs are available through many major brokerages, banks, credit unions, and other financial institutions that are allowed to serve as IRA trustees or custodians. In many cases, you can open an account online in a few minutes.

The basic process often looks something like this:

1. Choose a financial institution that offers IRAs.
2. Decide whether you are opening a Traditional IRA, a Roth IRA, or both.
3. Connect a bank account or another funding source.
4. Make a contribution and make sure it is designated for the correct tax year.
5. Choose how the money inside the IRA will actually be invested.
6. Keep track of the contribution limits and the tax rules that apply when money eventually comes out.

That fifth step is easy to overlook. An IRA is the tax-advantaged account, not the investment itself. You can open an IRA and deposit cash into it, but if the cash simply sits there, it may earn very little. The taxpayer still needs to decide how the money inside the IRA will be invested.

The financial institution also handles much of the tax reporting. For example:

• IRA contribution information is generally reported on Form 5498 by the IRA trustee or custodian.
• IRA distributions are generally reported on Form 1099-R.

Those forms help document what happened, but remember one of our recurring tax ideas: the form does not create the tax rule. You still need to know whether the contribution was allowed, whether it was deductible, and what tax consequences apply to a distribution.

Opening and contributing to an IRA can therefore be very simple mechanically. The important part is staying within the annual contribution limit, understanding whether the contribution is deductible or eligible for Roth treatment, and checking the withdrawal rules before taking money back out.

5. Traditional IRA deductions and phaseouts

A Traditional IRA contribution does not automatically mean the taxpayer gets a full deduction.

The first question is whether the person making the IRA contribution is covered by a retirement plan at work. If the taxpayer is married, we also need to know whether the taxpayer’s spouse is covered by a retirement plan at work.

Why does that matter? A useful way to think about the policy is this:

If you already have access to tax-favored retirement benefits through work, Congress begins limiting the extra Traditional IRA deduction at a lower income level. If you do not have a workplace retirement plan, the deduction is generally more available.

That does not mean a person with a 401(k) cannot also have an IRA. It means the workplace plan can change how much of the Traditional IRA contribution is deductible.

First ask: who is covered by a plan at work?

For an actual return, one easy clue is the Retirement plan box on Form W-2. If that box is checked, the employee was generally covered by a retirement plan at work for purposes of the IRA deduction rules.

Then separate the situation into three broad possibilities:

1. The IRA owner is covered by a plan at work. The deduction can phase out at a relatively lower income level.
2. The IRA owner is not covered, but the spouse is. The deduction can still phase out, but the phaseout begins at a much higher income level for a joint return.
3. Neither spouse is covered by a plan at work. The Traditional IRA deduction generally is not reduced by an income phaseout, although the normal contribution and compensation limits still apply.

Check the current Traditional IRA deduction rules in IRS Publication 590-A.

The deduction belongs to a person, not just to the joint return

This is especially important for married couples.

An IRA is an individual retirement arrangement. Each spouse has a separate IRA, and the deduction rules are applied separately to each spouse’s contribution—even when the couple files one joint tax return.

Suppose Maya and Jordan file jointly and have MAGI of $135,000. Maya is covered by a 401(k) at work. Jordan is not covered by a retirement plan at work. Assume both are otherwise eligible to make IRA contributions.

If each contributes $6,000 to a Traditional IRA, the two contributions do not automatically receive the same deduction treatment:

MAYA
Covered by retirement plan at work       Yes
Traditional IRA contribution          $6,000
Deduction rule                         Covered-person phaseout applies

JORDAN
Covered by retirement plan at work        No
Spouse covered at work                    Yes
Traditional IRA contribution          $6,000
Deduction rule                         Spouse-covered phaseout applies

At $135,000 of joint MAGI, Maya may be inside the lower phaseout range that applies to a contributor who is covered at work, while Jordan can still be well below the much higher phaseout range that applies when only the spouse is covered.

So even though Maya and Jordan file one return, we still ask separately:

Whose IRA received the contribution, and what deduction rules apply to that person?

That can matter in tax planning. If a married couple can afford to fund only one IRA, and one spouse is covered by a workplace plan while the other is not, the current deduction may be different depending on which spouse’s IRA actually receives the contribution.

Do not think of the IRA deduction as one family-sized bucket that can simply be assigned to whichever spouse gives the best result after the fact. The contribution is made to a particular person’s IRA, and that person’s deduction is determined under that person’s coverage situation.

A spouse can still contribute to an IRA

A spouse does not necessarily need their own wages in order to have an IRA contribution. Married couples filing jointly may be able to use the spousal IRA rules when one spouse has little or no compensation, as long as the couple has enough qualifying compensation overall and the other requirements are met.

The account is still that spouse’s own IRA. The rule simply allows the couple’s compensation to support the contribution.

Then apply the phaseout math

Once you know whose IRA it is and which coverage rule applies, the rest of the process should look familiar:

1. Calculate MAGI for the Traditional IRA deduction. Remember to ask: Which modifications does this rule require?
2. Find the correct phaseout range for that person’s filing status and workplace-plan situation.
3. Determine how far the taxpayer is through the phaseout range.
4. Calculate how much of the deduction remains.
5. Do a reasonableness check: if MAGI is before the midpoint, more than half of the deduction should generally remain; if MAGI is after the midpoint, less than half should generally remain.

Review the phaseout calculation and midpoint reasonableness check.

The durable lesson is not to memorize one year’s income ranges. It is to recognize why there are different ranges, identify which person’s rules apply, and then use the current-year numbers.

A rollover is not a new annual contribution

Moving existing retirement money from one qualifying retirement account to another is not the same thing as making a new annual IRA contribution. A properly completed rollover generally does not use up the regular annual IRA contribution limit.

That distinction matters because the dollars may look identical once they reach the IRA, but their tax history is different.

6. Roth IRAs and Roth 401(k)s

The same Roth timing idea can appear in different retirement arrangements.

Roth IRA

A Roth IRA contribution generally does not create a current deduction. The contribution is made with income that remains taxable now. If the requirements for a qualified distribution are satisfied later, the distribution generally is not included in taxable income.

But there is another important rule: not everyone is allowed to make the full direct contribution to a Roth IRA.

Roth IRA contributions are subject to an income phaseout. As a taxpayer’s modified adjusted gross income (MAGI) rises through the phaseout range, the amount the taxpayer is allowed to contribute directly to a Roth IRA is gradually reduced. Once MAGI reaches the top of the range, the taxpayer generally cannot make a direct Roth IRA contribution for that year.

That is different from the Traditional IRA phaseout we just discussed:

Traditional IRA phaseout → may reduce the DEDUCTION
Roth IRA phaseout        → may reduce the CONTRIBUTION itself

So when you are considering a Roth IRA, there are really two separate questions:

1. What is the annual IRA contribution limit?
2. Does the Roth IRA income phaseout reduce how much this taxpayer is allowed to contribute?

The Roth phaseout uses MAGI, which brings us back to our recurring question: Which modifications does this rule require? The exact phaseout ranges change over time, so check the current-year rules when you are working with an actual taxpayer.

Check the current Roth IRA contribution rules in IRS Publication 590-A.

Roth 401(k)

A Roth 401(k) uses the same basic tax now, benefit later idea inside a workplace plan. The employee generally does not receive the current federal income-tax subtraction that a traditional 401(k) contribution would provide, but qualified Roth distributions can receive favorable treatment later.

Again, the key distinction is not the word IRA or 401(k). The first question is:

Is this Traditional treatment or Roth treatment?

7. Taking money out: contributions, earnings, and the early-withdrawal rules

Retirement accounts receive special tax treatment because Congress wants to encourage retirement saving. The tradeoff is that the law generally discourages using the money too early.

A useful starting point is age 59½. Under current rules, withdrawals before age 59½ can trigger an additional 10% tax unless an exception applies. But the result depends heavily on whether we are talking about a Traditional IRA, a Roth IRA, or another retirement plan.

Traditional IRA: taxable money generally stays taxable

If a taxpayer took a deduction for a Traditional IRA contribution, neither the deductible contribution nor the investment earnings have been taxed yet.

When those amounts come out later, they are generally included in income.

If taxable amounts come out before age 59½, the taxpayer generally has:

Regular income tax on the taxable distribution
+ 10% additional tax on the early taxable distribution
  unless an exception applies

The extra 10% tax is commonly called an early-withdrawal penalty, although the tax law technically treats it as an additional tax.

Some IRA exceptions remove the 10% additional tax

The exception rules are detailed and can change, so you should check the current rule when you encounter an early distribution. Common current IRA exceptions include certain distributions for:

• qualified higher-education expenses;
• a qualifying first-home purchase, subject to a lifetime limit;
• certain unreimbursed medical expenses;
• health-insurance premiums during qualifying periods of unemployment;
• disability or death;
• certain birth or adoption expenses;
• certain emergency personal expenses.

There are additional exceptions as well.

An important distinction:

Avoiding the 10% additional tax does not automatically make the distribution tax-free.

For example, a qualifying education withdrawal from a Traditional IRA might escape the 10% additional tax while the taxable portion of the distribution is still included in income.

And do not assume every IRA exception works the same way for a 401(k). The exception lists are not identical across all retirement arrangements.

See the IRS’s current list of exceptions to the additional tax on early distributions.

Roth IRA: your regular contributions come out first

Roth IRAs have a feature that is especially useful for personal financial planning.

Under the Roth IRA ordering rules, regular contributions are treated as coming out first. Because those regular contributions were made with money that had already been taxed, a return of those contributions is generally not included in income and is not subject to the 10% additional tax.

That means a taxpayer who has contributed $20,000 of regular contributions to Roth IRAs over time can generally withdraw up to that $20,000 before reaching the investment earnings in the account.

The simplified order is:

Roth IRA withdrawals are generally treated as coming from:

1. Regular contributions
2. Conversion and rollover amounts
3. Investment earnings

This is very different from saying that all Roth IRA money can always be withdrawn tax-free. Converted amounts have additional rules, and earnings have their own requirements.

When can Roth IRA earnings come out tax-free?

For a Roth IRA distribution to be fully qualified, the Roth IRA generally must satisfy a five-tax-year holding period and the distribution must meet a qualifying condition, such as being made after age 59½. Other qualifying events can also apply.

So there are two useful rules to keep separate:

Regular Roth IRA contributions: generally available first, without income tax or the 10% additional tax.

Roth IRA earnings: generally need the qualified-distribution rules before they can come out completely tax-free.

Review the current Roth IRA distribution rules in IRS Publication 590-B.

8. Required minimum distributions: Congress eventually wants the deferred tax

Traditional retirement accounts can postpone tax for a very long time, but Congress generally does not allow the taxpayer to postpone it forever.

Eventually, many owners of Traditional IRAs and other pre-tax retirement accounts must begin taking required minimum distributions (RMDs).

Those forced distributions generally cause some of the deferred income to enter the tax system.

The exact required beginning age has changed over time and can change again. Under current law, the applicable RMD starting age is generally 73 or 75 depending on birth year. The durable concept is more important than memorizing one age: Traditional tax deferral generally cannot continue forever.

Check the current RMD rules when you need the actual starting age and calculation.

9. Tax planning with retirement accounts

Retirement planning is where the tax rules become real financial decisions. The account is not valuable merely because the tax code gives it a special name. The tax treatment can change how much money you eventually keep.

First: get the employer match if you can

Many 401(k) plans offer an employer match. The exact formula varies by employer, but the basic idea is that the employer contributes additional money when the employee contributes.

If your employer offers a match and you can afford to participate, contributing enough to receive the full match is often one of the highest-value first steps in retirement saving.

Suppose an employer matches 50% of the first $2,000 you contribute.

Your contribution                     $2,000
Employer match                         1,000
                                      ------
Amount added to retirement account    $3,000

You contributed $2,000, but $3,000 went into the account.

People often call the match free money. That is a useful way to think about the value, although you should still check the plan’s rules. Some employer contributions can be subject to a vesting schedule, which can affect how much of the employer contribution you keep if you leave the job quickly.

The IRS has a short explanation of employer matching contributions.

Why tax-sheltered growth matters

A retirement account does more than change the tax treatment of the original contribution. It also gives the investments inside the account a chance to grow without some of the annual tax drag that can occur in a regular taxable investment account.

To see why that matters, let’s compare three people who have the same $100-per-month after-tax cost for 10 years. We will use made-up rates so that we can focus on the structure rather than any particular year’s tax law.

Assume:

• a 20% marginal income-tax rate today;
• the same 20% income-tax rate when Traditional money is withdrawn;
• a 7% annual investment return;
• in the taxable account, part of the return comes from dividends that are taxed along the way, and the remaining capital gain is taxed when the investment is sold;
• a 15% tax rate on those taxable dividends and capital gains;
• no fees.

Roth IRA: $100 per month

The Roth saver receives no deduction today, so the full $100 comes out of after-tax money. But the investment growth is not taxed each year inside the Roth, and we will assume the eventual withdrawal is qualified.

$100 per month for 10 years at 7%

Total contributed                     $12,000
Approximate ending value              $17,105
Tax on qualified Roth withdrawal            0
                                       -------
Amount available                      $17,105

Traditional account: invest the tax savings too

A fair Traditional-versus-Roth comparison has to account for the current deduction. If the taxpayer is in a 20% marginal tax bracket, contributing $125 to a Traditional account can reduce current income tax by about $25.

Traditional contribution                 $125
Approximate current tax savings at 20%     25
                                          ---
Approximate reduction in take-home pay    $100

So the Traditional saver can put $125 into the retirement account for roughly the same $100 current after-tax cost as the $100 Roth contribution.

$125 per month for 10 years at 7%

Approximate ending value              $21,381
20% tax when withdrawn                 (4,276)
                                       -------
Amount available after tax             $17,105

Under these simplified assumptions, Traditional and Roth end in the same place because we assumed the same tax rate now and later and we invested the current Traditional tax savings instead of spending it.

That is an important planning idea: the current Traditional deduction can let you put more money to work today.

Regular taxable account: some growth leaks out to taxes

The taxable-account saver also invests $100 per month, but there is no special retirement-account shelter. In this example, taxable dividends create tax along the way, so not all of each year’s investment return stays invested and compounds. When the investment is sold at the end, the remaining capital gain is also taxed.

Using our simplified assumptions, the result is approximately:

$100 per month for 10 years
Same 7% underlying investment return

Value before final capital-gain tax    $16,835
Final capital-gain tax                    (541)
                                       -------
Amount available after tax             $16,294

The taxable account ends with less even though the underlying investment earned the same assumed return. The difference comes from tax drag: some of the investment return was lost to tax before it could remain invested and continue compounding.

This is a simplified teaching example. Real taxable investments can generate interest, qualified or nonqualified dividends, capital-gain distributions, realized gains, or unrealized appreciation, and each can receive different tax treatment. But the larger point remains:

Keeping investment growth sheltered from current taxation can leave more money compounding for you instead of sending part of the growth to taxes along the way.

It also shows why a fair Traditional-versus-Roth comparison cannot simply put $100 into each account and stop there. A Traditional contribution can create current tax savings, and those savings have value if they are also saved rather than spent.

Starting early can matter more than contributing a lot later

Compounding has another consequence: time matters enormously.

Here is a deliberately simple illustration. Assume a 7% annual return, monthly compounding, no fees, and no taxes inside the account.

Early saver: contributes $200 per month from age 25 through age 34—only 10 years—and then contributes nothing else.

Later saver: waits until age 35, then contributes the same $200 per month all the way through age 64—30 years.

At age 65, the approximate results are:

EARLY SAVER
$200/month for 10 years
Total contributed                     $24,000
Approximate value at age 65          $281,000

LATER SAVER
$200/month for 30 years
Total contributed                     $72,000
Approximate value at age 65          $244,000

The later saver contributed three times as much money and still ended with less in this hypothetical example.

Why? The early saver gave the first dollars decades longer to compound.

The return is hypothetical and actual investment returns are never guaranteed. But the lesson is durable:

Starting earlier gives time a chance to do more of the work.

Traditional or Roth? Think about tax rates over time

There is no universal winner between Traditional and Roth.

One important consideration is the taxpayer’s marginal tax rate now compared with the expected marginal tax rate later.

Suppose a taxpayer could receive a $5,000 Traditional deduction today while in a 12% marginal tax bracket.

$5,000 deduction × 12% marginal rate = $600 approximate current tax savings

If the taxpayer expects the same dollars to face a much higher tax rate later, Roth treatment may become more attractive. If today’s marginal rate is high and the future rate is expected to be lower, the current Traditional deduction may look more valuable.

That is only part of the decision. Cash flow, employer matching, future tax law, withdrawal flexibility, RMDs, and other considerations can matter too.

A Roth IRA can give you more flexibility than you might expect

One concern students often have about retirement saving is:

What if I need the money before I am 59½? Am I locking it away for decades?

That concern is one reason I like the flexibility of a Roth IRA.

Remember the Roth IRA ordering rule from earlier: regular contributions are treated as coming out first. Those contributions were already made with after-tax money. As a result, regular Roth IRA contributions can generally be withdrawn without income tax or the 10% additional tax, even before age 59½.

Suppose you have made $12,000 of regular Roth IRA contributions over several years and the account has grown to $15,000.

Roth IRA balance                       $15,000
Regular contributions                  $12,000
Investment earnings                      3,000

Under the Roth IRA ordering rules, the first $12,000 distributed would generally be treated as a return of regular contributions. The $3,000 of earnings is different and is subject to the Roth qualified-distribution rules we discussed earlier.

That does not mean I would plan to raid a Roth IRA every time an unexpected expense comes up. Once money leaves the account, you give up future tax-advantaged growth that the money could have earned. An emergency fund still serves a different purpose.

But this feature can make a Roth IRA less intimidating for a young saver who is worried about putting every available dollar somewhere completely inaccessible.

Also, be careful not to transfer this rule automatically to a Roth 401(k). A Roth 401(k) is a workplace retirement plan, and the plan’s distribution restrictions apply. You generally cannot treat Roth 401(k) employee contributions as freely withdrawable in the same way as regular Roth IRA contributions.

So another planning question is:

How much access to the money do I want before retirement?

For some taxpayers, Roth IRA flexibility is a meaningful part of the Traditional-versus-Roth decision—not just today’s tax rate.

An IRA can sometimes help after the year has already ended

Tax planning gets harder after December 31 because most of the taxpayer’s decisions for the year have already happened. The wages were earned. The investment was sold. The business expense was paid—or was not paid.

An IRA can be unusual because a taxpayer can generally make an IRA contribution for the prior tax year up to the tax-return filing deadline, not including extensions.

That can make a deductible Traditional IRA contribution one of the tools still available after year-end.

Suppose a taxpayer’s preliminary AGI is $82,000 and the taxpayer can still make a $5,000 deductible Traditional IRA contribution for that year.

Preliminary AGI                       $82,000
Deductible Traditional IRA            (5,000)
                                      -------
Revised AGI                           $77,000

The obvious benefit is the deduction itself. But sometimes the lower AGI can also affect another deduction, credit, limitation, or phaseout.

That means the value of the IRA deduction can sometimes be amplified beyond simply multiplying the deduction by the marginal tax rate.

But be careful: not every tax benefit uses regular AGI, and some MAGI formulas may add the IRA deduction back. So the correct planning question is not simply “Can I lower AGI?” It is:

If I lower AGI, which other tax rules actually use that lower number?

This is a good example of why understanding the tax structure matters more than memorizing isolated deductions.

IRS Publication 590-A explains the current IRA contribution deadline and contribution rules.

10. Other retirement arrangements

IRAs and 401(k)s are the arrangements you are most likely to hear about, but they are not the only ones.

For example, you may encounter:

• 403(b) plans;
• SEP arrangements;
• SIMPLE arrangements;
• retirement plans designed for self-employed taxpayers or small businesses.

You do not need to master all of those contribution calculations here. The important goal is recognition.

If a self-employed taxpayer says, “I want to save some of my business income for retirement,” you should remember that special retirement options exist and that you need to check the current rules for the arrangement being considered.

See Self-Employed Adjustments for how those rules fit into the tax map.

11. One complication: a Traditional IRA contribution is not always deductible

Now that the basic Traditional-versus-Roth distinction, the main retirement arrangements, and the withdrawal rules are clear, we can add one complication.

The word Traditional tells us the general tax idea, but a contribution to a Traditional IRA does not always produce a current deduction.

A taxpayer may be allowed to contribute to a Traditional IRA even when some or all of that contribution is nondeductible under the current rules.

Why would anyone do that if there is no deduction?

Because there can still be a tax benefit.

The investment earnings and gains inside the Traditional IRA generally are not taxed each year while they remain in the account. The growth is tax-deferred until distributions occur.

The nondeductible contribution itself creates basis in the IRA because that money was already taxed before it went in. That basis matters later because the taxpayer should not be taxed a second time on the same money.

So a nondeductible Traditional IRA has two pieces to keep track of:

Nondeductible contribution → already-taxed basis
Investment growth          → generally tax-deferred until distribution

When money later comes out of a Traditional IRA that has basis, part of the distribution may be tax-free return of basis and part may be taxable. The detailed calculation uses additional rules, including Form 8606.

You do not need to master that calculation here. What I want you to recognize is:

No current deduction does not mean there is no tax benefit at all.

And this is another place where Traditional and Roth IRAs differ. Roth IRA ordering rules generally let regular contributions come out first. A Traditional IRA with basis uses a different allocation system, so do not assume you can simply declare that a particular withdrawal came only from the nondeductible contributions.

If you encounter a nondeductible Traditional IRA contribution, that is a signal to stop and check the basis and reporting rules.

Now try it

Maya has four retirement-related items during the year:

1. $5,000 contributed through payroll to a traditional 401(k);
2. $2,000 contributed directly to a Roth IRA;
3. $3,000 contributed to a Traditional IRA that is fully deductible under the assumed facts; and
4. $20,000 moved in a proper rollover from an old workplace retirement plan to an IRA.

Which amounts create a new deduction on Maya’s individual income-tax return?