Traditional IRA vs Roth IRA

When you're planning your financial future, few things are as easy as opening an IRA (Individual Retirement Account), but which one is best? Well there really isn't a right or wrong answer, it really depends on your circumstances. Below we'll go over both traditional IRAs and Roth IRAs and hopefully with this information you can have a better idea on which one is right for you.

IRA Contribution Limits (Traditional & Roth IRA)
$5000.00 for 2009 and indexed for inflation for 2010 and beyond.

There is a “catch up” contribution, this is a $1000 “catch up” limit for 2009 and indexed for inflation for 2010 and beyond.

Phase-Out & Limit

Traditional IRA

 Year Single Joint and/or Married
 2009 $55,000-$65,000 $89,000-$109,000
 2010 & Beyond
 Indexed to Inflation
 Indexed to Inflation

Roth IRA

 Year Single Joint and/or Married
 2009 $105,000-$120,000 $166,000-$176,000
 2010 & Beyond
 Limit Removal
 Limit Removal

Restrictions & Requirements for Withdraw:
Age needed to withdraw – 59 ½, if withdrawn before 59 ½, subject to a 10% penalty fee.

Certain exceptions to the early withdraw penalty fee:
Higher education for account owner or eligible family members
Disability of account owner
Account owner has deceased
Medical expenses (must exceed 7.5% of AGI – Adjusted Gross Income)
First time home purchase (limit of $10,000)
For paying back taxes owed to the IRS (IRS places levy against account)
Medical insurance (account owner must previously receive 12 weeks of unemployment)
“Substantially equal periodic payments” over the life expectancy of the account owner

Traditional IRA

The key benefit with a traditional IRA is the amount you contribute is tax deductible. For example, if you contributed $3,000 to your traditional IRA and made $35,0000 this year, your taxable income for this year would $32,000. Moreover, the money you have in the IRA and earn from the IRA isn't taxable until you withdraw the money, which would be taxed at the current rate at that point in the future. The age for withdraw (without penalty) is 59 ½. However, if you were to withdraw funds before 59 ½, you would taxed on it, as well as hit with the 10% penalty fee. The tax benefits with a traditional IRA are good for your current taxable income, what you contribute can be tax deductible, but something to consider is what will your tax rate be 10, 20 or more years in the future?

Immediate tax benefits
Possible lower tax bracket when withdrawn during retirement
Risk that lawmakers may change the current tax benefits with a Roth IRA

Money contributed to the account and gains from the account will be taxed at the future current rates
Forced distribution based on age - Withdraws must begin at age 70 ½ years
Eligibility requirements for the tax deductions
Lower income limits for contributing

Roth IRA

The key benefit with a Roth IRA isn't until you begin withdrawing funds (59 ½). Because you are paying taxes on the money you contribute now, you won't be taxed on it when you withdraw it (provided you are over the minimum age requirement of 59 ½ or account has been opened "seasoned" for 5 years - if under 59 1/2). In essence, the total you have in your Roth IRA when retired or at least 59 ½, is 100% tax free. However, there are other factors to consider... If you are in a fairly high tax bracket now, you won't be receiving any tax benefits or breaks now by contributing to a Roth IRA. It's quite possible by the time you reach retirement or at least 59 ½, your tax bracket will be less than what is was the majority of your working years.

Tax free withdraws when you meet the requirements to withdraw (age 59 ½ & 5 year seasoning)
Higher income individuals & joint/married couples can contribute to a Roth IRA.
No mandatory distribution based on age
Roth IRA can be passed on to heirs

No immediate tax benefits
One may not live to retirement or long into it. Predicting life expectancy is tough to do and you'd have to live out and deplete your Roth IRA to fully realize the tax benefit
The potential for lawmakers to change the current tax benefits Roth IRAs offer now

Something to consider or ask your adviser about:
Consider opening a traditional IRA early on in your working years, because during this period, you are likely in the highest tax bracket, which could give you immediate tax benefits. Down the road, when you're in a better tax bracket, consider transferring the Traditional IRA to a Roth IRA. 

What can a retirement account do for you

Just to give you an idea of what a retirement account could mean to your future - Lets say you're 25 years old and contributing $5,000 a year to a Roth IRA with an estimated return rate of 5%. You continue to contribute $5000 a year until you retire at age 60 (fairly young retirement - by today's standards). When you're 60, you would then have an account balance of $474,182 and could withdraw $29,377 every year until you're 90. While you won't be living on easy street at 30k a year, it's certainly something that will help, especially if you combined that income with a 401k or other retirement/investment accounts.

Please contact a qualified financial adviser and/or tax adviser for complete details. This serves only as a quick, basic summary and is not to be considered as advice in anyway. Each circumstance is unique and seeking professional advise, from someone who can fully inform you of all options, is strongly recommended.

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