IRA or Roth IRA?

IRAs can be part of the foundation of a financially secure retirement. For many years, millions of individuals have made annual contributions to IRAs or used them to receive distributions from retirement plans on changing jobs or retiring. A few years ago, a new form of IRA was created called the Roth IRA. The Roth IRA offers some advantages over the Traditional IRA but comes with some limitations.

Here is a comparison of some of the key features of each:

Eligibility
Anyone under the age of 70 ½ with earned income can contribute to a Traditional IRA. For a Roth IRA, you must still have earned income but there is no age restriction. However, there are income limits for Roth IRAs. See the current listing of contribution and deduction limits. [PDF]

Taxability of Earnings
Earnings on funds in a Traditional IRA are tax deferred. Roth IRAs provide for tax-free growth.

Contribution Limits
The contribution limits for both types of IRAs are the same. In all cases, contributions must not exceed earned income. See the current listing of contribution and deduction limits. [PDF]

Deductibility of Contributions
Contributions to Traditional IRAs are deductible if you do not participate in another qualified plan. If you are a plan participant, contributions may be deductible depending on your adjusted gross income. Contributions to a Roth IRA are not tax deductible. See the current listing of contribution and deduction limits. [PDF]

Taxability of Withdrawals
For Traditional IRAs, any earnings and deductible contributions are subject to tax on withdrawal. All distributions from a Roth IRA are tax-free.

Penalty for Early Withdrawals
Both types of IRAs impose a 10% early withdrawal penalty tax on distributions taken before reaching age 59 ½. There are a few exceptions for death, severe hardship and other situations.

Mandatory Distributions
For a Traditional IRA, you must start taking distributions in the year you reach age 70

Which IRA is right for you?
If your income level precludes you from getting a deduction for contributions, the answer is easy – choose the Roth IRA.

If your contributions to a Traditional IRA would be deductible, the question is harder. Generally, if you are younger, the attraction of tax-free distributions would outweigh the immediate benefit of the deductions. If you expect your marginal tax rates to remain at their current level or increase, the odds favor the Roth IRA. If you have significant other assets and would like to use your IRA to pass significant wealth on to future generations, the tax-free nature of the Roth IRA is extremely attractive.

Should You Convert Your Traditional IRA to a Roth IRA?
There are some special rules that enable you to convert a Traditional IRA into a Roth IRA. Many people find that the attractions of tax-free distributions and no required distributions make a Roth IRA conversion worth considering. Beginning in 2010, the income limitations for conversions to Roth IRAs were eliminated and many people may now find this opportunity attractive. However, converting a Traditional IRA to a Roth IRA requires you to pay tax on the amount in the account. Be sure to consult your tax advisor if you believe converting makes sense. Most professionals have software that can help with the analysis.

As with any investment plan, please contact your tax advisor for questions on how the plan might affect your taxes.