Roth vs. Traditional

Is a Roth IRA right for you?
Congress created a new retirement investment option in 1997 called the Roth IRA. There are significant differences between a Roth IRA and a Traditional IRA. Below we outline the key features of a Roth IRA. Because of the tax implications, we encourage you to discuss your situation with your tax advisor before deciding to invest in a Roth IRA.

The Roth IRA does not allow deductible contributions, but it lets earnings grow federal income tax free and allows investors to make tax-free, penalty-free withdrawals when the account has been open for at least five years and when any of the following conditions are met:

  • The investor is at least 59 1/2 years old.
  • The funds will be used to purchase a first home.
  • The investor has died or become disabled.

In some cases, exemptions for educational expenses, medical expenses, and health insurance (in situations of unemployment) may also apply.

In addition, investors may withdraw their contributions from their Roth IRAs at any time without consequence (only earnings are subject to a tax or a penalty), and investors may continue to fund a Roth IRA for as long as they have earned income.

Certain individuals can make contributions to this account up to a maximum of 100% of earned income or $4,000 ($5,000 for persons aged 50 or older), whichever is less, for tax year 2007. In 2008, the limit increases to $5,000 plus the $1,000 catch-up contribution for those aged 50 or older,

There is a phase-out of eligibility to make a Roth IRA contribution if your adjusted gross income (AGI) for tax year 2007 is between $99,000 and $114,000 for single filers; between $156,000 and $166,000 for married joint filers; and between $0 and $10,000 for married separate filers. Contributions to a Roth IRA reduce dollar for dollar the amount that can be put into a traditional IRA for that tax year.

(You can, however, fund a Roth IRA and a SEP, SIMPLE, and/or Coverdell Education Savings Account in the same tax year. The above mentioned limit applies only to the combination of traditional and Roth IRAs.)

The differences in the deductibility of contributions and the taxation of earnings lead to different potential returns for the traditional and the Roth IRA, depending on your tax situation now and in the future. At their simplest, the scenarios look like this:

  • If you expect your income tax rate to be lower in retirement than it is now, you ma be better off with a traditional IRA.
  • If you expect your tax rate to stay the same or rise in retirement, you may be better off with a Roth IRA.

You should also consider how many years you will invest in the account before you begin to withdraw money from it. The longer you can invest, generally the stronger the case becomes for a Roth. A teenager earning part-time wages or a young professional just starting a career is an ideal candidate; he or she has many years to invest and can anticipate being in a higher tax bracket at the end of a career than at the beginning. A couple in their fifties looking at a drop of income at retirement may be better off with a traditional IRA.

Converting to a Roth IRA
You can generally convert your Traditional IRA to a Roth IRA, but only if you meet the following conditions:

  • Your adjusted gross income must be $100,000 or less. This limitation applies to single filers, head-of-household filers and married couples filing jointly. (Married taxpayers filing separate returns may not convert their regular IRAs to Roth IRAs, regardless of their AGI.)
  • You must pay taxes on all earnings (interest, dividends, and capital gains) and deductible contributions.

Before converting to a Roth IRA, you may want to explore the following:

  • Has the state in which you file taxes adopted all the federal guidelines for the new account?
  • Can you afford to pay taxes on the rollover without tapping the IRA itself?
  • Is it worth paying the taxes now in exchange for higher, tax-free earnings later?

Making such calculations can be complex, and you may need the help of a professional tax advisor.

The information presented here does not constitute tax advice. State tax regulations may differ from federal tax regulations. Always consult your personal tax advisor before making any tax-related investment decision.