Traditional IRA Basics
An Individual Retirement Account (IRA) is an individually-owned tax-advantaged account that anyone with earned income can open at a bank, brokerage, or other financial institution. Unlike a 401(k), an IRA is not tied to an employer — it travels with you regardless of job changes, and you have full control over investment selection across the entire universe of publicly available securities. The 2024 contribution limit is $7,000, or $8,000 for those aged 50 and older.
Traditional IRA contributions may be tax-deductible, but deductibility depends on two factors: whether you (or your spouse) participate in a workplace retirement plan, and your income level. If neither you nor your spouse has access to a workplace plan, contributions are fully deductible at any income level. If you do have a workplace plan, the deduction phases out between $77,000 and $87,000 of modified adjusted gross income for single filers, and between $123,000 and $143,000 for married filing jointly, in 2024. Above those thresholds, contributions are still allowed but receive no deduction.
Even a non-deductible Traditional IRA contribution provides value through tax-deferred growth — dividends and capital gains inside the account compound without annual taxation. However, non-deductible contributions require careful tracking using IRS Form 8606, which establishes your "basis" — the after-tax money in the account. Basis is critical because it determines what portion of future withdrawals is tax-free. Failure to file Form 8606 or to retain records of past filings can result in paying tax twice on the same money years later.
The IRA contribution deadline is April 15 of the following tax year, allowing you to make a prior-year contribution after you know your exact income. This flexibility is particularly useful for self-employed individuals whose annual income is difficult to predict.
Roth IRA Basics and Income Limits
Roth IRA contributions are made with after-tax dollars — there is no deduction — but the payoff is that qualified withdrawals, including all investment growth, are completely tax-free. A withdrawal is qualified if the account has been open at least five years and the account holder is at least 59½. The five-year clock starts on January 1 of the tax year for which the first Roth IRA contribution was made — not the calendar date of the contribution itself.
The income limit restricts who can contribute directly to a Roth IRA. The ability to contribute phases out between $146,000 and $161,000 of modified adjusted gross income for single filers, and between $230,000 and $240,000 for married filing jointly in 2024. Above the upper limit, direct Roth contributions are not permitted. This restriction does not apply to Roth 401(k) contributions through an employer plan — any employee can make Roth 401(k) contributions regardless of income.
Unlike Traditional IRAs, Roth IRAs have no Required Minimum Distributions during the original owner's lifetime. This is a significant estate planning advantage: Roth assets can grow tax-free indefinitely while the owner lives, and beneficiaries receive tax-free withdrawals (subject to a 10-year distribution rule). The absence of RMDs also makes the Roth the preferred account to leave untouched longest, drawing down pre-tax accounts first in retirement to manage taxable income.
Roth IRA contributions — not earnings — can be withdrawn at any time without tax or penalty, regardless of age or account age. This distinguishes the Roth from a Traditional IRA and makes it more flexible as a financial backstop. However, withdrawing retirement savings early, even tax-free contributions, reduces decades of potential tax-free compounding and should be reserved for genuine emergencies after other options are exhausted.
The Backdoor Roth
Taxpayers whose income exceeds the Roth contribution limit can still fund a Roth IRA through the "backdoor" technique. The process involves two steps: make a non-deductible contribution to a Traditional IRA, then convert it to a Roth IRA. The IRS has explicitly acknowledged this technique in congressional testimony and formal guidance, and there is no indication it will be prohibited, though legislative proposals to restrict it have occasionally appeared.
The conversion of non-deductible (after-tax) Traditional IRA dollars to Roth is generally tax-free, since the money was contributed without a deduction — the tax was already paid. The conversion triggers a taxable event only to the extent the converted amount represents pre-tax money. In a clean execution where the only Traditional IRA money is the freshly contributed non-deductible amount, the conversion produces little or no taxable income.
The critical complication is the pro-rata rule under IRC Section 72(e). If you hold any pre-tax Traditional IRA funds at year-end — in any Traditional, SEP, or SIMPLE IRA, at any institution — the IRS treats all your IRA dollars as a single pool for conversion purposes. The taxable fraction of any conversion equals the proportion of pre-tax money in the total pool. For example, if you have $90,000 in a pre-tax rollover IRA and contribute $7,000 non-deductible and immediately convert, 93% of the conversion ($90,000 ÷ $97,000) is taxable, not tax-free. The pro-rata rule cannot be avoided by designating which dollars you are converting.
The most effective way to sidestep the pro-rata rule is to roll pre-tax IRA funds into a current employer's 401(k) plan before year-end, reducing or eliminating the pre-tax IRA balance. Many 401(k) plans accept incoming rollovers. With the pre-tax IRA balance at zero, a non-deductible contribution followed by immediate conversion produces a clean, tax-free backdoor Roth. The timing of the conversion relative to the contribution is flexible — many practitioners recommend converting within the same tax year to simplify record-keeping.
SEP-IRA and SIMPLE IRA for Business Owners
Self-employed individuals and small business owners have access to IRA-based retirement plans with dramatically higher contribution limits than the individual IRA. These plans combine the simplicity of IRA administration with contribution capacities approaching those of large employer 401(k) plans, making them powerful tools for business owners who want to shelter substantial income from current taxation.
The SEP-IRA (Simplified Employee Pension) allows contributions of up to 25% of net self-employment income, with a 2024 maximum of $69,000 — nearly ten times the regular IRA limit. Contributions are fully deductible and grow tax-deferred. Setup requires minimal paperwork: a single IRS form (Form 5305-SEP or an equivalent brokerage document) rather than the complex plan documents required for a full 401(k). The main limitation is that SEP-IRA contributions must be made at the same percentage of compensation for all eligible employees — a business owner who contributes 20% of their own income must also contribute 20% for every eligible employee.
The SIMPLE IRA (Savings Incentive Match Plan for Employees) is designed for small businesses with 100 or fewer employees. Employees can defer up to $16,000 of salary in 2024, with a $3,500 catch-up for those aged 50 or older. Employers must contribute either a dollar-for-dollar match up to 3% of compensation or a flat 2% nonelective contribution for all eligible employees, regardless of whether they participate. Unlike the SEP, the SIMPLE allows employee salary deferrals, making it function more like a small-business 401(k). The SIMPLE IRA has a unique two-year rule: funds cannot be rolled into another type of retirement account within the first two years of participation without triggering a 25% penalty.
For the self-employed with no employees (or only a spouse), the Solo 401(k) — technically not an IRA variant — is often superior to the SEP-IRA because it allows both employee deferrals and employer profit-sharing contributions, enabling higher total contributions at lower income levels. However, SEP-IRAs and SIMPLE IRAs require less ongoing administration than a Solo 401(k) and remain the preferred choice for many small business operators who value simplicity.