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Comparing Traditional And Roth IRAs

Which is best for you, a Roth or a traditional IRA? If your income exceeds the income limits of traditional IRAs, or if you work for a company with a qualified retirement plan, then the Roth IRA is an obvious choice.

Otherwise, the decision is more complicated. From a purely financial standpoint, you can use our Regular IRA vs. Roth IRA Tool to calculate which IRA will provide the most retirement income, the Retirement Planning Tool to determine how much you can contribute, and the Should I Convert My IRA to a Roth IRA Tool to evaluate what it might be worth to convert IRAs.

The financial comparisons between the 2 types of IRAs are straightforward, but the differing rules governing when and how you can access money in the account (especially before retirement) complicate the matter.

Features of the Traditional IRA

Tax laws often change every you and certain restrictions, requirements and limitations may apply to IRAs to take advantage of their favorable tax treatment. They are defined in IRS Publication 590, Individual Retirement Arrangements. It is also helpful to talk with your tax adviser. Staying on top of tax laws is a full time job!

  • An individual can contribute up $4000 per year ($4,500 if over 50) for 2005

  • Modified AGI limite for traditional IRA contributions increased. For 2005, if you are covered by a retirement plan at work, your deduction for contributions to a traditional IRA will be reduced (phased out) if your modified adjusted gross income (AGI) is:
    • More than $70,000 but less than $80,000 for a married couple filing a joint return or qualifying widow(er).
    • More than $50,000 but less than $60,000 for a single individual or head of the household, or
    • Less than $10,000 for a married individual filing a separate retrun.
  • All earnings in the account are tax-deferred until withdrawal.

  • Penalty free withdrawal may start at age 59 ½. Prior to that age, withdrawals are subject to a 10% penalty and your income tax.

  • If you’re not eligible to deduct your contribution, you can still save in an IRA. Resulting tax-deferred earnings growth and compounding is still worthwhile, even if you don’t get the deduction. But if you’re eligible for the Roth IRA, it might be a better choice.

  • You can withdraw up to $10,000 penalty-free once in a lifetime to buy a first home for yourself or anyone in your family. You can make an unlimited penalty-free withdrawal to pay for college tuition or major medical expenses (if greater than 7.5% of your adjusted gross income). However, keep in mind that you will have to pay income tax.

Features of Roth IRAs

  • With a Roth IRA, there is no deduction for money invested.

  • All withdrawals made after 59 ½ are tax free (once the account has been open 5 years).

  • You can withdraw the amount invested at any time without penalty or tax. The earnings, however, are subject to penalty and tax.

  • Unlike the traditional IRA, there are maximum income limits for eligibility: currently $95,000 for singles and $150,000 for couples. Traditional IRAs have much lower deductibility limits but don’t have income limits for non-deductible contributions.
  • The Roth contribution is phased out when your adjusted gross income surpasses $95,000. Your contribution is reduced by $10 for each $75 your AGI exceeds $95,000. At $110,000, your allowed contribution would be  $0.
  • Unlike traditional IRAs, there is no mandatory withdrawal in retirement. This makes Roth IRAs attractive for passing wealth tax-free to heirs.

  • Like traditional IRAs, there is a 10% penalty for early earnings withdrawals. The same exceptions for home purchase, college tuition, and medical expenses apply.

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