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Some of the factors to consider when deciding whether to open a Roth or a Traditional IRA are the following, each of which are discussed in other sections of this article:

Before moving forward, it's important to have an understanding of the various types of IRAs, eligibility requirements and the rules about contributions, the rules for administering your IRAs and for withdrawing or distributing funds.

NOTE: While there are low limits on the amount you can contribute to a Roth IRA (such as $5,000 and $6,000), individuals with more than $100,000 in annual income and couples with more than $176,000 in annual income can roll over their money from traditional IRAs into Roth accounts.

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Review the rules for eligibility for making contributions to a Traditional IRA.

If you can't make deductible contributions to an IRA because you're covered by a retirement plan at work and earn more than the levels described, you should, by default, think about a Roth IRA.

Current and Future Tax Brackets

Do you think you'll be in a lower tax bracket upon retirement or disability than you are now? If, for example, you're single and earning $20,000 a year, then you are already in the lowest tax bracket. Therefore, the tax-deferral advantage of a traditional IRA is lost (but not the advantage of paying less taxes now, when you may need the extra cash). A Roth might be better for you if you can afford to pay your full taxes now.

On the other hand, let's say:

  • You're in mid-career, earning $100,000 a year.
  • You work for a small new business that doesn't offer a retirement plan.
  • The only retirement savings you have will be your IRA and you have no disability insurance.

In this case, a traditional IRA might be better for you. You'll be saving 31% in Federal income taxes on the money you contribute, letting your money grow without paying taxes on the earnings as they accumulate. You will only pay taxes on it when you withdraw the money. At that time, your taxable income will probably be low enough so that you end up paying 0 or 15% of the amount withdrawn in taxes -- depending on the amount of distribution you take and any other income.

How Much Money Can You Afford to Put Aside?

If you can't contribute a full $4,000 but still want to maximize your contribution, you might for that reason consider a traditional IRA. With a traditional IRA, you might be able to take a full $4,000 deduction even if you have less cash on hand at the time you file your return, say if you're due a tax refund. For example, if you're in a 28% tax bracket, you can put $4,000 into a regular IRA at a "cost" of only $2,880. That's because the $4,000 you deduct from your taxable income will generate $1,220 in income tax savings. Depending on timing, you might be able to actually receive that $1,220 before your contribution deadline arrives. Then, you could add that $1,220 to $2880 and make the full contribution. If this works for you, consider orchestrating it this way:

Step 1. File your taxes indicating a $4,000 contribution (you don't have to actually make the contribution until the filing due date on the return.)

Step 2. Receive a refund or owe less in the amount of $4,000 times your tax bracket.

Step 3. Use the savings or increased refund to help make the IRA contribution that you reported.

CAUTION: If you use this strategy, be sure to file your return as early as possible, and be confident that your refund amount calculated is correct. If you don't make the required IRA contribution by the filing deadline date (usually April 15 of the following year), you will have to file an amended return and face possible penalties and interest on the amount by which you underpaid your taxes.

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When Will You Need the Money?

Under a traditional IRA, you must begin withdrawing from your IRA the year after the year in which you turn age 70.

If you expect that you won't need the money at age 70 and will want to postpone withdrawing funds for as long as possible to avoid paying income taxes on it, then a Roth might be better for you.

If you think you might need to access the money in your IRA account and don't meet one of the conditions for penalty-free distributions, a Roth might be preferable. That's because, with a Roth, you can make withdrawals at any time and only have to pay penalties when you withdraw more than the amount that was initially deposited.

If, however, you are able to make a premature withdrawal due to disability, for work or medical expenses, or for a first-time home purchase, (see conditions for penalty-free distributions for details), either type of account will allow you to withdraw money without penalties. However, you will have to pay taxes on the entire distribution from a traditional IRA.

Edited by: Peg Downey, CFP, NAPFA
Money Plans
Silver Spring, MD