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 – but the more you know before making a choice, the better off you’ll be.
To begin with, you’ll find 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’ve had your account for at least five years and you don’t begin taking withdrawals until you’re 59-1/2. 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’re 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’re single, and your adjusted gross income is more than $110,000, you cannot contribute to a Roth IRA; if you’re married and filing jointly, the limit is $160,000.
However, assuming your income level does permit you to choose between the two IRAs, you’ll 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’s far from a certainty- then you might come out ahead by selecting the traditional IRA. However, even this assumption requires some complex number crunching, so, before you make 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 70 – 1/2. But if you own a Roth IRA, you are never required to take withdrawals. So, if you are still working at 70 – 1/2, and you own a traditional IRA, you’ll 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’ll be forced to start taking withdrawals at 70-1/2, you might have significantly less to pass on than you would with a Roth IRA.
Clearly, there’s 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.
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