|
July 2008 |
|||||||
|
Which IRA Is Right for You? A Closer Look at the Roth VS. Traditional With an Individual Retirement Account (IRA) anybody can amass a small fortune during their working years. If you don't have a 401(k) with an employer match, socking away money in an IRA becomes a no-brainer. The tax-deferred growth is one of the biggest legal tax dodges available to us. But the question remains, which IRA to get: Traditional or a Roth? Unfortunately, this question isn't a no-brainer. 
Tax deferred and tax deductibleBoth the Traditional and the Roth IRA offer tax-deferments on the earnings, meaning that the money your investment earns won't be taxed until later enabling your pot of gold to grow a lot faster. Imagine amassing $500,000 in an IRA and earning 10% on that money in one year. You'd have $50,000 coming to you and being tax deferred, the government allows you to keep all of it, put it back in your IRA and generate even more compound earnings. Tax deferment can save you hundreds of thousands of dollars over the life of an IRA. But only the Traditional IRA is tax deductible, which means those eligible can claim a deduction when filing their taxes each year they contribute. So, those who contribute $3,000 to their Traditional IRA enjoy a $3,000 tax deduction on that year's taxes. Tax-free distributions Contributing to a Roth has no such tax deduction. The upside to the Roth comes at the other end of the savings journey, when you enjoy tax-free distributions. If you draw $40,000 from your Roth after age 59-1/2, you enjoy that money tax free. With the Traditional IRA, you might enjoy tax savings with your contribution each year. And the debate boils down to whether to pay more now and save later or save now and pay later? For many, the idea of tax-free earnings and tax-free distributions just feels good, so they concede the tax deduction each year. For others, they know the tax laws can change and they buy into the idea of holding onto one's money and view the tax deduction as a bird in the hand. Determining eligibility The eligibility requirements for each plan may be onerous, but at least for many of us, they help make the decision by eliminating one of our options. For instance, with the Traditional IRA, in 2005 the full tax deduction is unavailable to a single-filer with an income of $60,000 and who participates in a 401(k). If you're married, filing jointly, and both of you participate in a retirement plan at work, the income restriction is as little as $80,000. Eligibility charts are available online or you can see a tax advisor. If it turns out you aren't eligible for the tax deduction, a Roth clearly becomes the better choice. Other questions If the eligibility rules don't make the decision for you, here are some questions to consider. One is whether the immediate tax deduction is actually enabling you to save more in your Traditional IRA. If it is, that tax deduction becomes even more important. Another consideration is your tax bracket now and what you expect your tax bracket to be when you retire. If you're in a high tax bracket now, the tax-deduction might work out in the long run. Or if you expect a lavish retirement, you might want the tax-free distributions that come with the Roth. It's all pretty confusing, but one thing is clear: After your 401(k) plan at work, either IRA is a terrific investment. Don't let the Roth vs. Traditional debate delay your contributions. |
|
|
|
|
|||
