Traditional IRAs vs. Roth IRAs
Traditional or Roth... which type of IRA is best for you? The key is to look at:
- What tax bracket you expect to be in at retirement
- How long you expect to keep the money in the IRA
Read on to learn why.
Traditional IRA
The tax breaks for a traditional IRA are tax-deferred contributions. That means the money you contribute to your IRA is not taxed (subject to limitations based on income) until it is withdrawn, normally when you retire. Earnings on your contributions won't be taxed either until you withdraw the money.
For example, if you earn $30,000 during the year and put $3,000 of it into an IRA, you pay income tax that year on only $27,000. Your contribution grows tax-free through the years. And when you withdraw the money for your retirement – after age 59½ – the money you contributed and your earnings will be taxed as income at your ordinary income tax rate in the year of withdrawal. To be eligible to place your money into an IRA, you must have earned compensation. Compensation includes wages, salaries, fees, tips, bonuses, commission, and taxable alimony. If you are receiving Social Security, a retirement pension, or investment income as your only income, you are ineligible to put new money into an IRA.
If you withdraw the funds before age 59½, in most cases you'll have to pay income tax plus a 10 percent penalty on the amount withdrawn. However, in some situations the penalty can be waived. One example is funds used to pay for "qualified higher education expenses." Talk to your tax advisor about other exceptions and for more specific information.
Roth IRA
The tax breaks for a Roth IRA are different. Unlike contributions to traditional IRAs, Roth IRA contributions are never tax-deductible. Using the example from above, you would still be taxed on $30,000, even though you had put the same $3,000 into a Roth IRA. However, when you withdraw the money from a Roth IRA, all of it, including your earnings, is tax-free, once the account has been open for more than five years and you are over the age of 59½. All you have to do is to wait until you can withdraw it without penalty.
As you can see, the Roth offers tax-exempt rather than tax-deferred savings. While both kinds of IRA allow you to accumulate wealth without paying taxes on your profits, the traditional IRA leaves you with a tax bill for those profits (plus your initial contributions, if those were deducted when made). The Roth does not. As long as you follow the rules, you never pay taxes on your gains with a Roth IRA. Talk to your tax advisor for more specific information.
Check the comparison chart below for a quick look at Traditional IRA vs. Roth IRA.
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2007 Maximum contribution:
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$4,000 per person per year
$5,000 if age 50 or over.
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$4,000 per person per year
$5,000 if age 50 or over.
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| 2008 Maximum contribution: |
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$5,000 per person per year
$6,000 if age 50 or over. |
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$5,000 per person per year
$6,000 if age 50 or over. |
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Income limitations:
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None
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Single: $114,000,
Married: $166,000
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Federal tax deductibility:
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Deductible when income is below amounts stated in the tax code.
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Contributions are not deductible.
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Federal taxation at distribution:
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Contributions and interest are tax-deferred. Both are taxed as ordinary income when distributed.
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Because contributions are not deductible they are not taxed when distributed. Interest is not taxed if Roth IRA is in existence at least 5 years and the annuity owner is older than
age 59½.
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Age 70½ rules:
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Mandatory distributions. No further contributions allowed.
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No mandatory distributions until death of owner. Contributions may continue past
age 70½.
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Contribution deadline:
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April 15 of year following contribution year.
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April 15 of year following contribution year.
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Transfers (Direct Rollover/Conversions):
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Funds are transferred directly from one or more qualified retirement plan or traditional IRAs to another traditional IRA; generally no income taxes or IRS penalties are imposed.
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Transfer directly from Roth IRA to another Roth IRA; generally no income taxes or IRS penalties are imposed. Convert from certain qualified retirement plans or traditional IRAs to a Roth IRA; income taxes will be due, penalties if IRS rules not followed.
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Indirect Rollovers:
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Funds (less taxes withheld) sent to the owner who sends the gross amount within
60 days to a traditional IRA; generally no income taxes or IRS penalties are imposed. The taxes that were withheld can be claimed when taxes are filed.
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Funds from a Roth IRA are sent to the owner who sends them to a new Roth IRA within
60 days; generally no income taxes or IRS penalties are imposed.
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Early distributions:
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10 percent federal tax penalty for unqualified distributions.
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Distributions of principal OK; 10 percent federal tax penalty for unqualified distributions of interest.
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Have questions?
For information and help in choosing the products that may be right for you, call our member sales team at (866) 845-6665.
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