With the tax filing deadline rapidly approaching, many folks are considering putting money into a traditional IRA because they can deduct their contributions.
But before you do that, take a look at whether a Roth IRA might be a better move, especially for your long-term retirement goals.
The table below shows the major differences in these two individual retirement arrangements.
|Roth IRA||Traditional IRA|
|Maximum contribution amounts for 2011 and 2012 tax years||$5,000 or the actual amount of earned income; $6,000 if you’re age 50 or older||$5,000 or the actual amount of earned income; $6,000 if you’re age 50 or older|
|Age limit for contributions||None||70½|
|Earnings||Tax free||Tax deferred|
|Withdrawals in retirement||Tax free||Taxable|
|Early withdrawal considerations (some situations allow for early withdrawal without penalty)||Earnings may be withdrawn without taxes or penalties if you are age 59½ or older and your account has been open for at least five years.||Taxes due on funds withdrawn prior to retirement. Penalties assessed on withdrawals before age 59½.|
|Required distributions||None.||Required minimum distributions must begin at age 70½ or penalties apply.|
|Beneficiary considerations||Heirs generally face no tax consequences as long as the account has been in existence for at least five years.||Heirs must pay taxes on funds left to them to the extent that a distribution represents deductible contributions and investment earnings.|
While the potential deductibility -- and note I say potential; your workplace retirement plans, marital status and income could negate this tax saving -- is a good move for some taxpayers, you need to look at your yearly taxes within your larger overall financial strategy.
Remember that you'll eventually pay for that traditional IRA deduction when you start taking money out of it in retirement. The plan/hope is that you’ll be in a lower tax bracket when you retire than you are now, so you push your IRA tax bill to that future date.
But can we be sure of what our tax bracket will be many years down the road?
We're are always at the mercy of what Representatives, Senators and presidents, not to mention the hoards of lobbyists, might do to our tax system.
And what if your IRA investment really takes off, growing at a rate that could create a lot more money that would be taxable one day, possibly at a higher rate, when it is taken out of a traditional IRA?
But by paying your taxes up front on money you put into a Roth IRA, you won’t have to worry about taxes ever again, regardless of what happens in Congress or on Wall Street.
Roth IRA income issues: Of course, there are income considerations with a Roth. While anyone now can convert a traditional IRA to a Roth IRA regardless of income, you can’t open or contribute fully to a Roth if you make a lot of money.
For 2011, your contribution to a Roth IRA is phased out if as a single or head-of-household filer your modified adjusted gross income was between $107,000 and $121,999. Make $122,000 or more and you can't contribute to a Roth.
For married joint return filers, the phase-out range is between $169,000 and $178,999. A joint income of $179,000 or more means the couple can't contribute to Roth IRAs.
For 2012, the income phase-out ranges are a bit wider: $110,000 to $124,999 for single and head-of-household filers and $173,000 to $182,999 for married taxpayers who file jointly. Exceed those top income limits for your filing status and you can't contribute to a Roth.
For both 2011 and 2012, if your filing status is married filing separately and you lived with your spouse at any time during the year, you cannot make a Roth IRA contribution if your modified AGI is $10,000 or more.
However, once you establish a Roth IRA, say by rolling over all or part of a traditional IRA since that income restriction is now gone, the balance in the Roth plan remains tax-sheltered even if your income rises above the threshold.
Roths are particularly beneficial for younger workers who are lower tax brackets now and who can take advantage of many, many years of tax-free growth in the account.
But regardless of your age, run the numbers and see what opening or converting to a Roth IRA could mean to your retirement savings. It could make your golden years more comfortable and definitely ease some retirement time tax issues.
Roth IRA Movement: This blog item is just one of hundreds about Roth IRAs posted by personal finance bloggers today. The special Roth IRA movement is the brainchild of Jeff Rose, a CFP and author of Good Financial Cents blog. A few weeks ago Jeff spoke at his alma mater and when he asked the 50 students if they knew what a Roth IRA was, no a single hand went up.
That moment Jeff realized that "more young adults need to know what the Roth IRA is and how it can have a tremendous impact on their life." And the Roth IRA Movement was born. He asked personal finance bloggers to post today on the Roth IRA. You can see what others had to say at today's round-up post by Jeff.
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