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An
IRA is certainly a great way to save
money for retirement. But which IRA is
right for you, traditional or Roth? As
is often the case in the investment
world, there's no one right answer for
everyone. The more you know before
making a choice, the better off you will
be.
To begin with, there are two
important differences between the IRAs.
First, a traditional IRA has the
potential to grow tax deferred, while a
Roth IRA's earnings have the potential
to grow completely tax-free, provided
you have had your account for at least
five years and you do not begin taking
withdrawals until you are 59½ . And
second, contributions to a traditional
IRA may be tax deductible (depending on
your income and whether you or your
spouse have access to an
employer-sponsored retirement plan),
while Roth IRA contributions are never
deductible.
On the other hand, the
traditional and Roth IRAs share some
things in common. Both have the same
contribution limits ($4,000 in 2007, or
$5,000 in 2007 if you are 50 or older)
and both can be funded annually with
virtually any type of investment:
stocks, bonds, Certificates of Deposit,
etc.
So, given both the
differences and the similarities, which
IRA should you choose? Actually, you
might not even have a choice. If you are
single, and your adjusted gross income
is more than $110,000, you cannot
contribute to a Roth IRA; if you are
married and filing jointly, the limit is
$160,000.
However, assuming your
income level does permits you to choose
between the two IRAs, you need to ask a
key question: Does the potential tax
deduction offered by a traditional IRA
outweigh the advantage of the Roth IRA's
tax-free earnings? As a (very) general
rule, you might say that if you can make
deductible contributions and you are
going to be in a lower tax bracket upon
retirement – and that is far from a
certainty – you might come out ahead by
selecting the traditional IRA. However,
even this assumption requires some
complex number-crunching. Before you
made any decisions, consult with your
tax professional.
Apart from this comparison,
what other factors could help you choose
between a Roth or traditional IRA?
Consider the following:
-
Your estimated retirement age. If
you have a traditional IRA, you must
start taking withdrawals when you
reach 70½. But if you own a Roth
IRA, you are never required to take
withdrawals. So, if you are still
working at 70½ and you own a
traditional IRA, you will have to
take withdrawals, and pay taxes on
them, while simultaneously paying
income taxes on the compensation
from your job.
-
Your need for retirement income. If
you think you will be able to
preserve a good chunk of your IRA,
then you might find it advantageous
to own a Roth IRA, which can
continue potentially growing,
tax-free, until your death, when it
will pass on to your heirs. Of
course, you can also leave a
traditional IRA in your estate, but,
since you will be forced to start
taking withdrawals at 70½, you
might have significantly less to
pass on than you would with a Roth
IRA.
Clearly, there is a lot to
consider when choosing between a
traditional IRA and a Roth IRA. See your
tax advisor for help in making the right
choice, but don't wait too long to put
an IRA to work for you. |
