IRAs Which One is Right For You?

IRAs: Which One is Right For You?
M. Shane Gaddy

For many American workers, the world of retirement brings ideas of travel, time, and a healthy generation of growing grandchildren.

But, before this fantasy becomes reality, most will realize that years of planning are necessary in order to build a hearty nest egg to support this lifestyle.

Retirement planning can come in many forms, whether it is a 401-(k) plan, stock and bond investments, or real estate.

But one of the most popular options are Individual Retirement Accounts (IRAs), better known as a ‘Traditional IRA’ or a ‘Roth IRA’.

Both types can provide investors tax-deferred compounding of their earnings from the account and in the case of a Traditional IRA, a possible tax deduction for the contributions.

Both the Roth IRA and Traditional IRA share some characteristics, but also offer different advantages.

Each allow you to contribute a maximum of $4,000 each year to your account for the 2005, 2006 and 2007 tax years, but it is important to note that your total annual contributions in one or both types of accounts cannot exceed the $4,000 maximum per tax year for IRAs.

That means if you own both a traditional and a Roth IRA, you are still only able to contribute a total of $4,000 per year between the two types of accounts.

However, if you are 50 or older, you can contribute an additional amount to your IRAs, beyond the annual limit.

This amount is sometimes referred to as a “catch-up” contribution.

For example, if you are over the age of 50 you can contribute an extra $500 in 2005 and an extra $1,000 in the 2006 and 2007 tax years.

Differences between the Roth and Traditional IRAs begin with the existence of income restrictions.
While your contributions cannot exceed the amount you earn in a year, there are no income restrictions to participate in a traditional IRA.

In contrast, the Roth IRA carries income limits that vary based on your tax filing status.

Be sure to check with a financial professional as you make your plans.

Tax implications also differ between the two.

Contributions to a traditional IRA may be made on a pretax basis, meaning your withdrawals will generally be taxed as ordinary income, once you reach retirement age.

* With a Roth IRA however, you will pay taxes on the money before making your annual contribution, so when you withdraw those contributions, your withdrawals will be tax-free.

You may also withdraw your earnings tax-free from your Roth IRA after you reach age 59 ½, for the purchase of a new home or in the event of disability or death, provided you’ve held your Roth IRA for at least 5 years.*

Keep in mind, your age may also make a difference when you are considering a Roth or traditional IRA.

Traditional IRA contributions are not allowed for the tax year in which you turn age 70 ½, and beyond, but the Roth IRA allows you to continue making contributions beyond age 70 ½ as long as you are earning income.

Furthermore, when you turn 70 ½, you must begin taking mandatory distributions from a traditional IRA account, but with a Roth IRA, this is not a requirement.

If you are interested in opening an IRA and you haven’t done so by the end of the tax year, don’t worry. You are able to establish and fund either a traditional or a Roth IRA until taxes are due, usually April 15.

As time passes, it is easy to forget about the years ahead. But remember, today’s planning can lead to tomorrow’s comfort and security, when they are needed the most.

* Withdrawals prior to age 59 ½ may be subject to income tax and a 10% IRS penalty.