IRAs

ROTH OR TRADITIONAL; MAKING THE SMART IRA CHOICE

Planning for and individual retirement account (IRA) can be quite complicated. Taxpayers have several types of IRAs to choose from, all with different eligibility requirements and tax treatments to consider. In choosing the IRA that will produce the best tax and financial results for you, you should start by reviewing some IRA basics

Review traditional IRAs

Deductible: With a traditional deductible IRA, you take a tax deduction for the year that you make your contribution. Contributions and earnings grow tax-free until withdrawn, at which time they are subject to regular income tax.

Withdrawals must begin after you reach age 70 ½, and withdrawals before age 59 ½ are generally subject to a penalty.

If you have a company retirement plan at work and your income exceeds certain levels, you may not be eligible for a traditional deductible IRA.

Nondeductible: Contributions to a traditional nondeductible IRA do not generate a tax deduction. But once a contribution is made, nondeductible IRAs are treated much like deductible IRAs. Because contributions were not deductible, they are not taxed when eligible for withdrawal. Earnings in a nondeductible IRA grow tax free until withdrawn, and withdrawals must begin after you reach age 70 ½.
Spousal : Nonworking spouses are allowed to contribute up to $3,000 a year to a spousal IRA. A joint return must be filed, and total IRA contributions for both spouses cannot exceed their combined earnings.

Roth IRA

With a Roth IRA, contributions are not deductible, but there is an important, offsetting benefit: principal and earnings in a Roth IRA are never again subject to tax if you meet certain requirements.

Example: You contribute $2,000 annually to a Roth IRA. Although you receive no tax deduction, this IRA can grow to any amount and it will never again be subject to tax. And for the rest of your life, withdrawals may be as large or small as desired, provided the IRA has been in existence for at least five years and you are at least 59 ½ years old.

A Roth IRA is not subject to mandatory distribution requirements. Also, spousal Roth IRAs are permitted. Eligibility for a Roth IRA is phased out at income levels of $95,000 to $110,000 for singles and at $150,000 to $160,000 for couples.

Deductible, nondeductible, or Roth?

If you are eligible to contribute to all three types of IRAs—deductible, nondeductible, and Roth—you can safely ignore the nondeductible IRA, since it is clearly less attractive than the other two. But deciding between a deductible IRA and a Roth IRA can be very difficult.

If you expect your tax bracket to increase during retirement, or stay the same as it is now, a Roth IRA is probably a better choice than a deductible IRA.

But if you expect your tax bracket to be lower during retirement, or you simply do not know, you might want to opt for a deductible IRA.

When making the IRA decision, you also may need to consider other factors, such as length of time until retirement, expected rate of return on investments, and the relative amount of your IRA and non-IRA assets.

Comparison of Traditional and Roth IRAs

Assume you have decided to put $2,000 away every year for the next 20 years. You expect the account will earn an annual average rate of return of 10%, and your tax rate will be 28% before and after retirement.

	Traditional	Roth
Total Contribution to IRA	$ 40,000	$ 40,000
Tax Savings Invested ($560/ yr. @ 7.2% after tax)	$ 23,465	-0-
Accumulation in IRA ($40,000 plus 10% earnings)	$ 114,550	$ 114,550
Total accumulation	$ 138,015	$ 114,550
Tax on IRA withdrawals ($114,550 x 28%)	<$ 32,074>	-0-
Net accumulation	$105,941	$ 114,550

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