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Traditional IRA vs Roth IRA

Which IRA is Best?

One of the biggest financial planning problems may be the decision of which IRA you should contribute to: the Traditional or the Roth IRA. Because many factors must be taken into consideration, it is highly recommended that you seek professional tax advice to determine which product is best suited to your needs. The overall positive and negative aspects of each product are detailed as follows:

Traditional IRA

Positive

  • Contribution may be deductible if not covered by a QP or if covered by a QP and below the income phase out levels
  • Deduction can be taken at higher income tax bracket now and possibly pay taxes at lower income bracket when retired and in required distribution
  • Earnings are tax-deferred
  • No maximum income level for contribution eligibility

Negative

  • Contributions may not be tax-deductible depending upon your adjusted gross income
  • Income tax bracket may increase at retirement depending upon value of tax-deferred investments, etc
  • Distributions are taxable when withdrawn
  • Regular contributions can no longer be made once the owner attains the age of 70 1/2
  • Mandatory distributions are required beginning at age 70 1/2

Regular Roth IRA

Positive

  • Earnings on Roth IRAs are tax free when five year period has been met and the distribution is qualified
  • Contributions may continue after age 70 1/2 if the individual has earned income
  • Access principal at any time without an IRS penalty
  • Withdrawals are considered a return of principal first, then earnings
  • No mandatory distributions are required

Negative

  • Cannot deduct contributions made to a Roth
  • If earnings are withdrawn before the five year period is met and/or withdrawals are made under the age of 59 1/2, the earnings may be taxable and penalized
  • If adjusted gross income levels are too high, a contribution cannot be made into a Roth

Conversion Roth IRA

Positive

  • Larger balances can be converted to earn more tax free interest
  • Beginning in 2010, the maximum income limit for persons converting from Traditional to Roth IRAs is eliminated
  • No mandatory distributions required at age 70 1/2 from Roth IRAs
  • Income tax is paid now on converted IRAs to prevent beneficiaries from paying taxes later

Negative

  • All funds converted from a Traditional IRA which have not been taxed must be claimed as taxable income
  • The IRS imposes a 10% IRS penalty on the principal withdrawn on a conversion if the five year period is not met and the individual is under the age of 59 1/2
  • If earnings are withdrawn before the five year period (for each conversion) is met, the earnings may be taxable and penalized
  • The five year period for withdrawal of principal and earnings without penalty begins with each conversion

As you can see, the Roth IRA is an exciting retirement product but may not be for everyone. You should seek professional financial advice when deciding which is best for you.