One of the things that confused me when I first started looking in to getting my personal finances and retirement investing started was the difference between a Roth IRA and a Traditional IRA. For the most part these two types of IRA’s have similar tax advantages but depending on your situation one may be more advantageous than the other. If you aren’t looking for an explanation of Roth and Traditional IRA’s and just want to open one then you can get started by either opening an account at ING Direct or
Traditional IRA
A traditional IRA is a tax deferred retirement account that allows your investments to grow tax free until you reach 59 1/2 years of age. You can contribute any earned income to this account provided you are under the age of 70 and 1/2 years of age. It is important to point out that this income must be earned and not inherited or saved income, so you must have a job that pays you at least as much as you invest in your IRA. There are other options for people who don’t have this income.
The limits for the amount you can contribute is reset every few years but unlike a Roth IRA is not dependent on your modified adjusted gross income (MAGI). You can take a tax deduction on this contribution if you or your spouse are not covered by a retirement plan at work, but if you are both covered then a tax deduction may be limited for you.
When you take a distribution from your traditional IRA you are subject to taxation on this amount so it is very important for you to figure out whether or not your tax rate will be higher now or when you eventually retire. For most people your tax rate in the future will be higher since we all know government likes to spend our money. You can begin taking withdrawals at age 59 1/2 but there are certain situations where you may be able to take a withdrawal before then.
Roth IRA
A Roth IRA was created in 1997 to give investors another option for their retirement with tax benefits that impact them now instead of at a later date. Roth IRAs are limited in the amount of money you can invest each year and they are dependent on your modified adjusted gross income which we will outline below.
Where Roth’s differ is when it comes to distributions. Distributions from Roth IRAs are taken tax free at the time of distribution and provided you are age 59 1/ 2 or older there are no penalties. You can take distributions before 59 1/2 but only for a qualifying event.
IRA Contribution Limits
For 2009 the contribution limits for both a traditional and Roth IRA are set at $5,000 per year, unless you are age 50 or older then you could contribute up to $6,000 in what is called a catch up contribution. For Roth IRA you are only eligible if your MAGI is $105K-120K for single or $166K-176K for married filing jointly
Which IRA is right for you?
There is no way I can tell you what IRA is best for you, but many investors prefer the Roth IRA because you are taking care of the tax bill up front. Of course you must have a MAGI that qualifies and you must meet all other qualifications like having a job that pays you enough to contribute. Whichever option you choose IRA’s are a great source for retirement investing that you should all be taking advantage of.