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Traditional Vs Roth IRA

Individual Retirement Accounts can be part of the foundation of a financially secure retirement. For many years, millions of individuals have made annual contributions to IRAs or used them to receive distributions from retirement plans on changing jobs or retiring. A few years ago, a new form of IRA was created called the Roth IRA. The Roth IRA offers some advantages over the traditional IRA but comes with some limitations.

Here is a comparison of some of the key features of each.

Eligibility
Anyone under the age of 70 ½ with earned income can contribute to a traditional IRA. For a Roth IRA, you must still have earned income but there is no age restriction. However, there are income limits for Roth IRAs. Single tax return filers can make full contributions if their income is less than $95,000. The limit for joint filers is $150,000. Partial contributions are allowed if your income exceeds those amounts (up to $110,000 and $160,000 respectively).

Taxability of Earnings

Earnings on funds in a traditional IRA are tax deferred. Roth IRAs provide for tax-free growth.

Contribution Limits

The contribution limits for both types of IRAs are the same. In all cases, contributions must not exceed earned income.

2002 to 2004 contributions - up to $3000

2005 to 2007 contributions - up to $4000

2008 contributions - up to $5000

After 2008, the limits will be adjusted for inflation in $500 increments.

In addition, workers ages 50 and over can make additional “catch-up” contributions of $500 in years 2002 to 2005 and up to $1000 thereafter.

Deductibility of Contributions

Contributions to traditional IRAs are deductible if you do not participate in another qualified plan. If you are a plan participant, contributions may be deductible depending on your adjusted gross income.

For 2002 contributions – Single return filers – full deductibility if AGI is $34,000 or less and partial deductibility with AGI up to $44,000. For joint return filers, the limits are $54,000 and $64,000.

Contributions to a Roth IRA are not tax deductible.

Taxability of Withdrawals

For traditional IRAs, any earnings and deductible contributions are subject to tax on withdrawal. All distributions from a Roth IRA are tax-free.

Penalty for Early Withdrawals

Both types of IRAs impose a 10% early withdrawal penalty tax on distributions taken before reaching age 59 ½. There are a few exceptions for death, severe hardship and other situations.

Mandatory Distributions

For a traditional IRA, you must start taking distributions in the year you reach age 70 ½. There are no required distributions for the Roth IRA.