Traditional vs. Roth IRAs

Chapter scope

Individual retirement accounts (IRAs) allow investors to save for retirement outside of employer-sponsored plans.

This chapter covers two types:

• Traditional IRAs
• Roth IRAs

🔑 Numbers, ages & limits

⚠️ TRADITIONAL vs ROTH IRA — side-by-side (guaranteed exam topic)

Traditional IRAs

• Traditional IRAs are non-qualified retirement plans because they aren’t workplace-sponsored, even though they work similarly to qualified plans.
• Like most qualified plans, contributions are deductible against earned income.
• Example: an investor earning $50,000 who contributes $4,000 to a traditional IRA is taxed on $46,000 of earned income.
• Distributions are typically fully taxable as ordinary income.

Contribution limit

• 🔑 The contribution limit for IRAs in 2026 is the lesser of $7,500 or the amount of earned income during the year.
• To contribute, investors must have earned income. A contribution can’t be made if an investor has no reportable earned income.
  • Example: a person unemployed throughout the year is ineligible to make an IRA contribution.
  • Example: a person earning $3,000 from a part-time job throughout the year can contribute a maximum of $3,000 to their IRA.
• Investors may make IRA contributions annually up to the contribution limit.
• 🔑 They may also contribute for a specific tax year up until the tax-filing deadline the following year (typically April 15th).
  • Example: an investor can contribute toward 2025’s contribution limit until April 15th, 2026.
  • Contributions made between January 1st, 2026 and April 15th, 2026 must be specifically assigned to 2025 or 2026.

Footnotes from the text

Spousal IRAs

• Only individuals with earned income may contribute to IRAs. However, the IRS allows a working spouse to contribute to a non-working spouse’s IRA.
• Example: Parsa works and is married to John, who is unemployed. Although John has no reportable income, Parsa can contribute to John’s IRA on his behalf. This is referred to as a spousal IRA contribution.
• ⚠️ “Regardless of the name, the accounts are separate - there is no such thing as a joint IRA.”

Catch-up provision

• 🔑 Investors age 50 or older are eligible for a catch-up provision, allowing an additional contribution of $1,100 per year.
• This lets investors who missed contributions in earlier years build retirement savings faster.
• 🔑 In 2026, a person age 50 or older may contribute up to $8,600 ($7,500 + $1,100 catch-up).

Deductibility of contributions

⚠️ Traditional IRA contributions are not always deductible. Three situations determine the tax status of a contribution:

Covered by a qualified workplace plan means the investor can access a qualified retirement plan through work.

• Example: an investor working at a corporation that can contribute to a 401(k) is covered by a qualified plan.
• If an investor has no access to a qualified workplace plan like a 401(k), they can always deduct their contributions.
• If they do have access, deductibility depends on income level. In general, the higher the income, the less likely the investor can deduct the contribution.
• 📌 “You won’t need to know specific numbers, but you may see exam questions testing the general concept.”

Sidenote — Traditional IRA phaseouts

Taxpayers filing single (2026)

• Investors filing single can make a fully tax-deductible contribution if earning less than $81,000 annually. A phaseout begins between $81,000 and $91,000, meaning the investor may only deduct part of the contribution. Above $91,000, none of the contribution is tax-deductible.

Married taxpayers filing jointly (2026)

• Investors filing jointly can make a fully tax-deductible contribution if earning less than $129,000 annually. A phaseout begins between $129,000 and $149,000. Above $149,000, contributions are not tax-deductible.

Non-deductible contributions and rollovers

• ⚠️ Investors making non-deductible contributions to a traditional IRA are only taxed on the growth when a distribution (withdrawal) is taken. The basis (amount contributed) is returned to the investor tax-free upon withdrawal.
• When retiring or leaving a job with a qualified plan, many investors roll their retirement plan assets into IRAs.
• ⚠️ When money is rolled from one retirement plan to another, it is not a tax-reportable event (no taxes due).
• Moving retirement assets to an IRA keeps the assets tax-sheltered and can provide additional investment options.

Permitted / prohibited investments

• ⚠️ Footnote: “In particular, an investor cannot sell uncovered (naked) options due to the significant risk involved.”

Roth IRAs

• Roth IRAs are a newer retirement account created in the 1990s. Named after Senator William Roth, this type of IRA uses a “reverse” tax structure compared with many retirement plans.

Contributions

• Contributions are made after-tax, which means they are not deductible.
• Roth IRA assets grow tax-sheltered and can be withdrawn in retirement tax-free if specific requirements are met.
• 🔑 The same traditional IRA contribution limit of $7,500 per year applies to Roth IRAs.
• ⚠️ The contribution limit applies to both IRAs combined.
  • Example: an investor contributing $3,000 to a traditional IRA may only contribute $4,500 to a Roth IRA. If the account owner is age 50 or older, they could contribute an additional $1,100.
• ⚠️ Not all investors are eligible to contribute to Roth IRAs — in particular, investors with high incomes cannot contribute.
• 📌 “You won’t need to know the specific numbers for the exam, but they are included below for context.”

Sidenote — Roth IRA phaseouts

These are the phaseout limits for being eligible to contribute to a Roth IRA:

Taxpayers filing single (2026)

• Investors filing single can make a full Roth contribution if earning less than $153,000 annually. A phaseout begins between $153,000 and $168,000, meaning the investor may only make a partial contribution (of the $7,500 limit, or $8,600 if age 50 or above). Above $168,000, no Roth contributions may be made.

Married taxpayers filing jointly (2026)

• Investors filing jointly can make a full Roth contribution if earning less than $242,000 annually. A phaseout begins between $242,000 and $252,000, meaning the investor may only make a partial contribution (of the $7,500 limit, or $8,600 if age 50 or above). Above $252,000, no Roth contributions may be made.

Distributions

🔑 Roth IRA owners must meet two requirements to avoid taxes on distributions:

• Example: an investor opening their first Roth IRA at age 60 must wait until age 65 for tax-free withdrawals.
• 🔑 The five-year aging period for Roth IRAs starts on the first day of the tax year (typically January 1st) of their first contribution.
• ⚠️ Footnote: “Investors taking distributions above age 59 ½ but who haven’t reached the five-year aging period are subject to ordinary income taxes on the gains above basis, but not the 10% penalty.”
  • Example: a 60-year-old opens their first Roth IRA and contributes $5,000. Two years later the account is worth $8,000, and the investor requests a full withdrawal. They will pay ordinary income taxes on the $3,000 of growth, but no additional 10% penalty.

RMDs

• Most retirement plans are subject to required minimum distributions (RMDs) when the account owner turns 73.
• ⚠️ Roth IRAs are not subject to RMDs. Since taxes are not assessed when distributions occur, the IRS doesn’t require Roth IRA owners to take distributions.

Sidenote — Roth 401(k)s

Sidenote — Divorce & retirement plans

• Divorce is a fairly common event, with roughly 50% of all marriages ending in separation in the United States. One major issue in divorce is dividing jointly owned assets, and retirement plans are often part of that process.

QDRO process

• If the two parties agree on the amount to be split (e.g., two former spouses agree to split both their 401(k) plans 50/50), the agreement is made in divorce court and the presiding judge signs off on the QDRO.
• If there is no agreement, the divorce proceedings determine how the retirement plan(s) will be split, and the judge signs off on the final QDRO.
• Regardless of agreement or disagreement, the QDRO must comply with ERISA.
• The transfer incident to divorce process is similar to the QDRO process, but the order is not required to comply with ERISA.

Taxation when a plan is split

Inherited IRAs

• Many Americans die (hopefully at an old age) with balances in their IRAs. When this happens, beneficiaries (the people who inherit these accounts) must follow specific distribution rules.
• ⚠️ “The Internal Revenue Service (IRS) does not allow assets to remain in tax-sheltered accounts forever.”

Distribution rules fall into two categories based on the beneficiary:

• Spousal beneficiary
• Non-spouse beneficiary

Spousal beneficiary

One benefit of being married is added flexibility when inheriting IRA assets from a spouse.

Non-spouse beneficiary

There are two types of non-spouse beneficiaries:

Claim the assets into an inherited IRA — the primary option for non-spousal beneficiaries, although distribution methods may vary by beneficiary type:

Key points

Traditional IRAs

• Potentially deductible contributions
• 100% taxable distributions

Traditional IRA contributions

• 2026 contribution limit is lesser of:
  • $7,500
  • Annual earned income
• Age 50+ can contribute $1,100 more
• Spousal IRA allows non-working spouse contribution

Deductible traditional IRA contributions

• Always allowed if not covered by a qualified plan
• If covered by a qualified plan:
  • Deductible if low-mid income
  • Non-deductible if high income

Roth IRAs

• Non-deductible contributions
• 100% tax-free distributions if:
  • Age 59 1/2 or older
  • Roth IRA is aged 5 years

Roth IRA contributions

• 2026 contribution limit is lesser of:
  • $7,500
  • Annual earned income
• Contribution limits apply to both Roth and traditional IRAs combined
• Cannot contribute if high income

Roth 401(k)s

• Qualified workplace plan
• Similar tax structure to a Roth IRA

Qualified domestic relations order (QDRO)

• Orders qualified retirement assets to be split
• Typically utilized during divorce proceedings
• Distribution not taxable
• Receipt of funds may be taxable
  • Not taxable if placed into a similar retirement plan
  • Taxable as ordinary income if not placed into a similar retirement plan
  • No early withdrawal penalty

Transfer incident to divorce

• Orders non-qualified retirement assets to be split
• Utilized during divorce proceedings
• Distribution not taxable
• Receipt of funds may be taxable
  • Not taxable if placed into a similar retirement plan
  • Taxable as ordinary income if not placed into a similar retirement plan
  • Early withdrawal penalty applies if receiver below age 59 1/2

Beneficiary choices

Sources

Primary/official references for the material in this chapter. Every link was fetched and returned HTTP 200 on 2026-08-15.