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In today's busy, financial scene, two popular Individual Retirement Accounts (IRAs) vying for your attention are the traditional IRA and the Roth IRA. While both are long-term savings vehicles with tax benefits, each treats contributions, age, and income differently.
Contributions Perhaps the biggest difference between traditional IRAs and Roth IRAs is the nature of the contributions and how they are ultimately taxed. Contributions to traditional IRAs are pre-tax (deductible on the taxpayer's income tax return). Therefore, although contributions and earnings accumulate on a tax-deferred basis, income taxes are due when distributions from the IRA are taken. On the other hand, contributions to Roth IRAs are after-tax, and contributions and earnings accumulate tax-free. Therefore, no income tax is due when distributions are taken from Roth IRAs. For tax year 2002, contributions to traditional IRAs, Roth IRAs, or both are limited to a combined total of $3,000 ($3,500 for individuals age 50 or older).
Age Restrictions Contributions to traditional IRAs may not continue beyond age 70½, and required minimum distributions (RMDs) must begin by April 1st of the year after reaching age 70½ (or a 50% tax penalty may apply). In contrast, Roth IRAs have neither an age limit for contributions, nor minimum distribution requirements. However, both traditional and Roth IRAs have a minimum age for withdrawals—59½. Withdrawals made prior to age 59½ may be subject to a 10% federal income tax penalty. Certain situations qualify as exemptions, such as withdrawals made to pay for first-time homebuyer expenses or qualified education expenses. Furthermore, before tax-free withdrawals can be made from a Roth IRA, the account must be five years old.
Income Eligibility Limits Depending on your tax-filing status, your income, and whether or not you participate in a qualified employer-sponsored retirement plan, you may be eligible to take an income tax deduction for contributions to a traditional IRA. If you are a single taxpayer, do not participate in a qualified employer-sponsored plan, and earn a minimum of $3,000, contributions are deductible regardless of your adjusted gross income (AGI). However, if you do participate in an employer-sponsored retirement plan, income limits apply. Deductions phase out for single taxpayers with AGIs between $34,000 and $44,000, and for married couples filing jointly with AGIs between $54,000 and $64,000.The income eligibility requirements are different for Roth IRAs. If you participate in a qualified employer-sponsored retirement plan, you may contribute to a Roth IRA; however, if you are also contributing to a traditional IRA, your contributions may not exceed the annual contribution limits. You are eligible to make a full contribution to a Roth IRA if your AGI does not exceed $95,000 for single taxpayers or $150,000 for married taxpayers filing jointly (contributions phase out for single filers with AGIs between $95,000 and $110,000, and for joint filers with AGIs between $150,000 and $160,000). A Roth IRA is often a favored choice for those who participate in a qualified employer-sponsored retirement plan and exceed the income limits for a deductible IRA, but meet the income eligibility requirements for a Roth IRA.
Analyze Your Situation and Objectives As you investigate which IRA—or combination of IRAs—offers you the best bottom line, consider the following questions:
| 1. | What tax benefits, current and long-term, are available to you?
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| 2. | Would you like to make contributions beyond age 70½?
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| 3. | When do you anticipate needing IRA proceeds?
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An analysis of your personal financial situation and retirement objectives can help you develop a financial strategy targeted to meet your specific needs. Studying the details now, may save you time and money in the future.
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