A Roth IRA is not necessarily better than a traditional IRA. The inverse is also true. Your circumstances, ranging from income to tax filing status, to whether or not you or your spouse participates in a workplace retirement plan, dictate which one makes sense for you. There are, however, some real differences between the two products you should consider when determining whether to invest in a Roth IRA, traditional IRA or both.
A Roth IRA might be better for you if you think you will be in a higher tax bracket come retirement than you are now. This is because the IRS does not tax Roth withdrawals -- contributions or earnings -- after age 59 1/2 as long as you have held your Roth account for a minimum of five tax years. As IRS Publication 590 explains, you can deduct traditional IRA contributions from your taxable income -- a perk you don't get with a Roth -- but Uncle Sam taxes the entire amount of all traditional IRA withdrawals, irrespective of when you take them.
Both Roth and traditional IRAs provide the benefit of tax-deferred growth. Unlike a taxable investment account where you have to report and pay tax on earnings -- interest, capital gains, dividends -- annually, the IRS does not tax earnings until you access them in the case of a traditional IRA. As noted, with a Roth, you can get at your earnings tax free if you satisfy both the 59 1/2 and five-year rules. If you access Roth money early, for any reason, or you haven't held your account for at least five years at any point, the IRS will tax the earning's portion of the distribution.
While the actual thresholds vary from year to year, there is a chance you make too much money to contribute to a Roth IRA. As of November 2010, Publication 590 points out that your modified adjusted gross income must be less than $176,000 if you use married filing jointly status and less than $120,000 if you use single, head of household or married filing separately status and have not lived with your spouse at any time during the year. If you go with married filing separately and you lived with your spouse at some point during the year, the limits drops to $10,000. While the IRS may limit the deductible portion of your traditional IRA contributions, it does not use income limits to determine your eligibility for contributing to a traditional IRA in the first place.
A clear benefit of a Roth IRA is that the IRS never makes you take money out of it. Your account can keep growing as you age and your life ends. This provides a clear benefit for your beneficiaries. With a traditional IRA, however, the IRS makes you begin taking withdrawals in the year after you turn age 70-1/2, primarily because the agency has never saw its share of your tax-deductible contributions. If you fail to take your required minimum distribution in a given year, the IRS warns that it will slap a 50 percent excise tax on the amount you should have withdrawn.
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