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Traditional IRA vs Roth IRA

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Individual Retirement Accounts — IRAs — are a great way to salt away retirement savings, allowing your savings to grow tax free. You can set up an IRA with a brokerage house, investment firm, or other financial company that offers services to individual investors; usually, there’s a very low minimum investment to open an account, and you can then invest the IRA money in a broad selection of stocks, bonds, mutual funds, and other investment vehicles, depending on what’s for offer at the financial company you’ve selected — and depending on your stomach for risk!

IRAs come in two flavors: traditional IRA vs Roth IRA. Both types of accounts are tax advantaged, but they work in different ways, as follows.

Traditional IRAs were first offered as investment vehicles with the Employee Retirement Income Security Act of 1974 (ERISA). Anyone who earns taxable income and is under the age of 70½ can contribute to a regular IRA, to an annual limit of the equivalent of your total taxable earnings for the year or $5,000 (as of 2012), whichever amount is lower. (Savers over fifty years of age can contribute an additional $1,000 as a “catch-up” contribution, for a total of $6,000.) Your IRA account then grows, with capital gains and dividend earnings completely sheltered from tax. Traditional IRAs are only taxable when you begin to make withdrawals in retirement — and then your withdrawals are taxed as regular income.

Traditional IRA vs Roth IRA

Traditional IRA vs Roth IRA


The real benefit to traditional IRAs is that, for most people, annual contributions are tax deductible. If neither you nor your spouse is an active participant in an employer-sponsored retirement savings plan (such as a 401[k]), then you can (each) deduct the full amount of your contribution(s) to your IRA. However, if either you or your spouse does participate in a 401(k), then there are income limits specifying whether your contributions are fully deductible, partially deductible, or not deductible at all. For instance, a single filer with a 401(k) and a modified adjusted gross income of $56,000 or less (in 2012) can deduct the full amount of his or her traditional IRA contribution. If the modified AGI is from $56,000 to $66,000, then contributions are partially deductible. If your modified AGI is more than $66,000, then you can’t deduct your contribution.

For married couples filing jointly, the numbers are higher; if your modified AGI is $90,000 or less, your IRA contributions are fully deductible. Also, both you and your spouse can open IRAs for the full amount each, even if one spouse is not working. However, the working spouse must have taxable income of at least the amount of your combined contributions for the year.

Roth IRAs were first introduced in the Taxpayer Relief Act of 1997; they are named after Senator William Roth of Delaware, who sponsored the legislation. Roth IRAs are subject to the same annual contribution limits as regular IRAs, and Roth accounts are also tax sheltered as they grow over the years. However, there are two major differences between the two flavors of IRA account: while regular IRA contributions are tax deductible for most investors, Roth contributions are never tax deductible. However, withdrawals from regular IRA accounts are taxed as regular income; withdrawals from Roth accounts are not taxable at all, provided you’ve held a Roth account for at least five years before making your first withdrawal.

Not everyone can contribute to a Roth IRA. If you’re a single taxpayer, your modified AGI must be less than $110,000 (as of 2012) for you to be able to make a full contribution ($5,000 in 2012, or $6,000 if you’re over fifty years of age). You can make a partial contribution if your modified AGI is from $110,000 to $125,000, and you are ineligible to make a contribution if your modified AGI is higher than $125,000. For married couples filing jointly, these figures are adjusted up to $173,000 (if your modified AGI is below that, you can both make full contributions) and $183,000 (if the figure is above that, you are both ineligible).

In a nutshell, for most people, a traditional IRA gives a tax break up-front, whereas a Roth IRA provides the tax benefit at the back end. You’ll need to do some math to determine which flavor is best for you; for most people, Roth IRAs are a better deal in the long run, particularly if you believe you may be in a high tax bracket when you’re retired. Both IRAs offer more benefits than traditional savings or investment accounts, so they’re well worth investing in if you have extra money to put aside for retirement.

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IRA Calculator

IRA Calculator will help you determine:

IRA calculator helps you decide whether a Traditional or Roth IRA is best suited for your needs.

How much you need to withdraw each month once you retire to live comfortably
How much you need to contribute each month to maximize employer contribution for monthly retirement withdrawal goal
How you can forecast for your contributions’ affect on your retirement savings can be done through our online 401-K calculator.