How To Decide On A Roth Or Traditional Ira

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Most people in our community know an IRA is a great way to save money for retirement. But which IRA is right for you -- "traditional" or Roth? As is often the case in the investment world, there's no one "right answer" for everyone -- but the more you know before making a choice, the better off you'll be.

To begin with, you'll find two important differences between the IRAs. First, a traditional IRA has the potential to grow tax-deferred, while a Roth IRA's earnings can potentially grow tax-free, provided you've had your account for at least five years and you don't begin taking withdrawals until you're 59-1/2. And second, contributions to a traditional IRA may be tax-deductible (depending on your income and whether you or your spouse have access to an employer-sponsored retirement plan), while Roth IRA contributions are never deductible.

On the other hand, the traditional and Roth IRAs share some things in common. Both have the same contribution limits ($4,000 in 2007, or $5,000 if you're 50 or older) and both can be funded with virtually any type of investment -- stocks, bonds, Certificates of Deposit, etc.

So, given both the differences and the similarities, which IRA should you choose? Actually, you might not have a choice. If you're single, and your adjusted gross income is more than $110,000, you can't contribute to a Roth IRA; if you're married and filing jointly, the limit is $160,000.

However, assuming your income level does permits you to choose between the two IRAs, you'll need to ask a key question: Does the potential tax deduction offered by a traditional IRA outweigh the advantage of the Roth IRA's tax-free earnings? As a (very) general rule, you might say that if you can make deductible contributions and you are going to be in a lower tax bracket upon retirement -- and that's far from a certainty -- then you might come out ahead by selecting the traditional IRA. However, even this assumption requires some complex number-crunching, so, before you made any decisions, consult with your tax professional.

Apart from this comparison, what other factors could help you choose between a Roth and traditional IRA? Consider the following:

  • Your estimated retirement age. If you have a traditional IRA, you must start taking withdrawals when you reach 70-1/2. But if you own a Roth IRA, you are never required to take withdrawals. So, if you are still working at 70-1/2, and you own a traditional IRA, you'll have to take withdrawals, and pay taxes on them, while simultaneously paying income taxes on the compensation from your job.
  • Your need for retirement income. If you think you will be able to preserve a good chunk of your IRA, then you might find it advantageous to own a Roth IRA, which may continue to grow, tax-free, until your death, when it will pass on to your heirs. Of course, you can also leave a traditional IRA in your estate, but, since you'll be forced to start taking withdrawals at 70-1/2, you might have significantly less to pass on than you would with a Roth IRA.

Clearly, there's a lot to consider when choosing between a traditional IRA and a Roth IRA.

See your tax advisor for help in making the right choice -- but don't wait too long to put an IRA to work for you.

Scott Flake is a financial advisor with the firm of Edward Jones. For more information, call him at (928) 468-1470.

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