The confusion for many people comes when they are considering which type of IRA they should contribute to. One family member may assert the benefits of a Roth IRA while another insists a Traditional IRA is the way to go. Rather than avoid opening an IRA altogether, consider a few simple clarifications which will assist in determining which IRA option is best for you.
The most important way in which Roth and Traditional IRAs differ is this: money contributed to a Roth IRA is taxed by the government as it is deposited into an account. Meanwhile, money in a Traditional IRA is taxed as it is withdrawn from the account. When saving for retirement, these distinctions are the starting point to assessing IRA options.
With those differences in mind, another question to consider is what tax bracket potential contributors will be in during retirement. Will it be higher than the one they presently are in now? For someone just starting on their career road, chances are good that they are in a lower tax bracket now. But for those who may be only 10 to 15 years from retirement, the outlook is not as clear. It may be easy to assume that those in retirement are in a lower tax bracket than those who are established in their careers, as retirees' earnings are lower.
However, two critical elements could affect those assumptions. First, those who have contributed substantial retirement savings to 401(k)s and Traditional IRAs can typically expect to pay taxes on money they withdraw - and if they are maintaining their standard of living in retirement, those withdrawals may keep them in the same tax bracket. Secondly, it is expected that the government will raise taxes in the future.
The challenge in planning for retirement is that of course no one can predict what will happen in the future. However, for those who have a pretty clear sense of their career path and plans for retirement, the above clarifications should help in considering a Traditional IRA and Roth IRA.
IRA Basics
Traditional IRA
Eligibility is available to anyone under 70 years of age with no maximum income limits. In terms of deductibility, a Traditional IRA is deductible if an individual or the spouse is not covered by a 401 (k) plan or other employer-sponsored retirement plan. Deductibles will decline for an individual or spouse who participates in an employer-sponsored retirement plan with an adjusted gross income of $80,000-$100,000 (joint filers in 2007). Traditional IRA earnings grow tax-deferred and will be taxed at the time of withdrawal, which must start at age 70. Contributions are limited to $5,000 per year and $6,000 for individuals age 50 or above in 2008 and 2009.
The Roth IRA
Eligibility for the Roth IRA is open to those whose earned income is less than $114,000 (singles) or $166,000 (married, filing jointly) and there is no age limit. Money contributed to a Roth cannot be deducted at tax time. Both the principal and earnings are tax-free for those whose account has been established for five years or more and take the distributions after age 59. There is no age limit on withdrawals. In 2008 and 2009, contribution limits for the Roth are $5,000 ($6,000 for age 50 or above).
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