When planning retirement, many people go for Individual Retirement Arrangements (IRA) that allow them to save for their retirement with some tax advantages. However, choosing between different types of IRAs is a somewhat daunting task. The type of retirement account you choose will depend upon your specific requirements. For some people the ability to claim tax deductions may be the single most important factor, for others it may be the freedom to spend their retirement accounts with minimum restrictions. This article explains the basics of Traditional and Roth IRA and the major differences between them.
Traditional IRA
A traditional IRA, sometimes called ordinary or regular IRA, allows you to save for retirement if your age is below 70 1/2. The major advantage of a traditional IRA is that contributions to the account may be tax deductible. The ability to take a tax deduction for a contribution to your traditional IRA depends on several factors, namely your modified adjusted gross income, your tax-filing status and your participant status. A traditional IRA account holder is required to start making withdrawals from his account once he reaches the age of 70 1/2. The earnings and gains on your traditional IRA account are not taxable until they are distributed (withdrawn).
Roth IRA
Unlike a traditional IRA you cannot deduct contributions to a Roth IRA, but on the other hand, qualified distributions are tax free. There is no age limit for participating in a Roth IRA and further there is no condition that you start withdrawing from your retirement account once you reach the age of 70 1/2 (Required Minimum Distribution or RMD).
There are several factors to consider while choosing a retirement account that works best for you.
Deductibility: A traditional IRA account allows you to deduct your contributions depending upon factors such as your income, your filing status, whether you are covered by a retirement plan at work and whether you receive social security benefits. Contributions to a Roth IRA account are never tax deductible. The idea behind the Roth IRA is that you contribute to a Roth account after paying tax and you never pay tax upon withdrawal (subject to qualification requirements).
Contribution Limit: The contribution limit for a traditional and Roth IRA account are both the same. For the year 2008 it is $5000 for adults aged 49 and below and $6000 for individuals aged 50 and above. However, in a Roth IRA account the actual amount you can contribute may be less than that depending on your income, filing status and whether you contribute to another IRA.
Age Limit: For a traditional IRA your age must be less than 70 1/2. There is no such age limit for Roth IRA account.
Income Limit: In order to contribute to a Roth IRA your modified Adjusted Gross Income (AGI) should be less than:
(a) $166,000 for married filing jointly or qualifying widow(er)
(b) $114,000 for single, head of household, or married filing separately and you did not live with your spouse at any time during the year
(c) $10,000 for married filing separately and you lived with your spouse at any time during the year.
There are no such income limits for traditional IRA accounts.
Required Minimum Distributions: In a traditional IRA account, there is a condition that you must begin receiving required minimum distributions after the age of 701/2. There is no such restriction in Roth IRA.
Treatment of Distributions: Distributions from a traditional IRA are considered and taxed as ordinary income. If they are withdrawn before the account holder reaches the age of 59 1/2 an additional penalty applies.
Distributions from a Roth IRA are not taxed as long as they are qualified distributions.The following are the conditions for qualified distributions allowed in a Roth IRA account:
A) The account must have been maintained for a minimum of five calendar years AND
B) The distribution is taken for one of the following reasons
1.The distribution is made after your death
2.You are disabled
3.You are 59 1/2 or older
4.You are purchasing a house for the first time, in which case you eligible to withdraw a maximum of $10,000 dollars.
For more information on Traditonal IRA and Roth IRA accounts, visit the IRS Web site
Choosing between the two IRA accounts is a matter of personal choice. You have to carefully consider all the above factors before you decide on a type of retirement account. If you feel that you want the features of both the accounts, it is also possible to maintain both types of IRA accounts. However your maximum contribution cannot exceed the maximum limit set by IRS for the corresponding year.
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