Choosing a Roth vs a Traditional IRA

Is a Roth IRA for you, or should you stick with a traditional IRA? For some, the decision is an easy one; for example, if your income level or eligibility for an employer-provided 401(k) or retirement plan makes you ineligible for a tax-deductible Traditional IRA, then Roth is definitely the way to go. But what if you have a choice? How do you decide?

Eligibility: Traditional Tax-Decuctible IRA

First, determine if you're eligible to deduct contributions to a Traditional IRA from your taxable income. If neither you nor your spouse is covered by an employer's retirement plan, you're eligible to contribute to an IRA.

If you actively participate in a retirement plan at work, your traditional IRA contributions will be reduced when your modified Adjusted Gross Income reaches these amounts:

• More than $75,000 but less than $85,000 if you're married filing jointly or a qualifying widow(er).

• More than $50,000 but less than $60,000 for a single individual or head of household.

• Less than $10,000 for a married individual filing a separate return.

If your spouse was covered by a retirement plan at work, your contributions are reduced once your modified Adjusted Gross Income reaches certain levels, as follows:

• $150,000 if you're married filing jointly.

• Under $10,000 and you're married filing separately (partial contribution allowed)

• Over $160,000 (no contribution to a traditional IRA allowed).

The IRA contribution limit for 2006 is $4,000 (you must have earned at least $4,000 for the year. Otherwise you can only deduct the amount that you actually earned, up to $4,000). If you'll be 50 or older before 2007, you can deduct $5,000 (again, assuming you earned at least that much).

Eligibility: Roth IRA

Income levels are more liberal for the Roth IRA, and you can still establish and contribute to a Roth IRA even if you already participate in an employer-sponsored retirement plan such as a 401(k), Profit Sharing or Pension Plan and/or have an existing Traditional IRA, within certain income levels:

For Roth IRAs, in 2006 you can contribute the full $4,000 ($5,000 if you're over 50) as long as you had at least that much in earned income and your income doesn't exceed:

• $110,000 if you're single, head of household, or married filing separately and you didn't live with your spouse at any time during the year.

• $160,000 if you're married filing jointly or a qualifying widow(er).

• $10,000 if you're married filing separately and you lived with your spouse at any time during the year.

Will You Benefit More From a Roth IRA?

Traditional IRAs grow tax-deferred, which means you won't pay taxes on your contributions until you withdraw them, presumably at retirement. When you withdraw the funds, you'll pay taxes on both your contributions and the earnings.

You don't get a tax deduction when you make a contribution to a Roth IRA, but the beauty and power of Roth IRAs is that the earnings are always tax-free. This tax-free* growth, and the fact that Roth IRAs are not subject to the minimum distribution rules requiring withdrawals after age 70 1/2, are their major advantages.

Whether you will benefit more from a Roth IRA depends on variables such as how long it will be before you retire, when you plan to start taking distributions, and your tax bracket now and at the time of retirement.

Even if you're eligible to contribute to a tax-deductible Traditional IRA, you may benefit over the long run by investing in a Roth IRA instead.

The tax advantage of a Roth IRA increases with the number of years between the time you establish the Roth IRA and the time you begin taking distributions. To really determine whether you will come out ahead with a Roth, you have to do some number crunching and look at your total investment picture. You may want to talk to a tax accountant.

Converting to a Roth IRA

You can convert your Traditional IRA into a Roth IRA, but you'll have to pay taxes on the amount being converted at the time of conversion. Speak with an IRA advisor before making a decision about conversion.

Miscellaneous Details

You can set up an IRA with any financial institution authorized by the Internal Revenue Code, such as banks, trust companies, savings banks, brokerage firms or mutual fund companies.

You have until April 15th, 2007 to contribute to an IRA for 2006, but earlier in the year you make your contribution, the more earnings you'll accumulate.

*Refers to federal income taxes. State tax rules on Roth IRA distributions vary from state to state.

This article is meant as only a general overview of Roth versus Traditional IRAs. There are many other details that are covered in IRS Publication 590.

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