A regular, or traditional, IRA and a Roth IRA are both individual retirement accounts. They share many common elements, but also feature some distinct differences, primarily how they are taxed. You should determine for which plan you qualify and then consider the attributes of both to decide which might be a better investment for you and your long-term plans.
Traditional IRA Essential Features
Traditional IRA contributions are tax deductible and tax-deferred. This means that the year you contribute to a traditional IRA you may deduct that amount from your income taxes, thereby reducing your current tax burden. Tax-deferral means you also will not pay taxes on the increased value of the account until you withdraw funds. However, when you begin to take distributions during retirement, those withdrawals will be treated as income and be subject to regular income tax during the year of withdrawal. After a certain age, you must make annual withdrawals.
Roth IRA Essential Features
When you invest in a Roth IRA you receive no immediate tax benefit in the year you make the contribution. However, any increase in the account's value will not be taxed, it is not subject to capital gains tax, and if you withdraw your funds during retirement you will also not pay income taxes on the distributions. There are no mandatory distributions once you reach retirement age. If you expect that your personal income tax rate or income tax rates in general will be higher when you retire than they are now, you should strongly consider a Roth IRA.
If you are under the age of 50, through 2010 the maximum contribution to a Roth IRA or a traditional IRA is $5,000. The limit goes up to $6,000 per year in 2011 and is likely to increase over time. In either case, your contribution amount cannot exceed your modified adjusted gross income (AGI). For example, if you earn $4,000 in a calendar year, you may only contribute up to $4,000 to either type of IRA for that year.
If your modified AGI exceeds certain limits, the amount you are permitted to contribute to either type of IRA maxes out once you reach a particular income level, or if your income is too high, you may not be able to invest in these types of accounts at all. Income limits for both IRAs vary on a sliding scale and adjust regularly, so during the year you plan to contribute, you need to check with the IRS whether your income exceeds the current eligibility requirements. Even if you are ineligible to contribute fully, you might be still able to invest a smaller amount.
Important Things to Consider
One terrific feature of a Roth IRA is that you may contribute to one even if you already participate in a 401(k) retirement plan offered through your employer. It is sometimes possible to contribute to a traditional IRA and an employer-sponsored plan, but the regulations are complicated so you should contact a tax specialist. Both types of IRA enable your account to grow tax-free until you reach retirement age. For most people, a Roth IRA is likely to be the best long-term investment. You might have to pay taxes now, but you will not be taxed in the future.
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