How to Compare Roth & Traditional IRAs
IRAs are individual retirement accounts that are completely controlled by investors rather than by an employer like a 401k plan. There are two types of IRAs: Roth IRAs and traditional IRAs. These accounts have different tax advantages and different restrictions for who can contribute to them.
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Instructions
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Determine whether you qualify for a Roth IRA. In order to open and make contributions to a Roth IRA, your adjusted gross income must be below a certain level. This level depends on your filing status and is adjusted annually for inflation. For 2009, singles can make up to $105,000 and married couples can make up to $166,000 to be eligible to make the full contribution. If you are single and make between $105,000 and $120,000, married filing together and make between $166,000 and $176,000, or married filing separately and make between $0 and $10,000, you can make a partial contribution.
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Determine whether you qualify for a traditional IRA. To make contributions you must be younger than 70 1/2 years old and have taxable income. There is no income restriction on a traditional IRA.
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Determine if you are eligible to take a tax deduction for the traditional IRA. If you are not covered by a retirement plan at work, you can take the full deduction. If you are covered, you can take a full deduction if you make less than $55,000 and are single or $89,000 and are married filing jointly. If you make less than $65,000 as a single filer, less than $109,000 filing jointly with your spouse or less than $10,000 filing separately from your spouse, you can take a partial deduction. If you make more than these limits, you cannot deduct the contributions to a traditional IRA. If you cannot deduct your contributions to a traditional IRA, you are better off contributing to a Roth IRA if you are eligible.
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Compare the tax benefits. Both a Roth and a traditional IRA will allow your contributions to grow tax free while they are in the account. Traditional IRA contributions can usually be deducted from your taxes when you make them, but the contributions and earnings will be taxed when you withdraw them at retirement. Roth IRA contributions are not deductible when you make them, but the contributions and earnings are not taxed at retirement.
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Estimate whether you will be in a higher tax rate when you retire than you are in right now. If you expect to be making more at retirement, you are better off investing in a Roth IRA because the money will be tax free then. If you expect to be in a lower bracket, you are better off investing in a traditional IRA because the tax benefits will be greater now.
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Tips & Warnings
The contribution limit is cumulative for Roth IRAs and traditional IRAs. This means each dollar you contribute to a Roth IRA is one less dollar that you can contribute to a traditional IRA.
If you withdraw the money from any IRA before age 59 1/2, it will be subject to a 10 percent penalty unless it is a qualified early withdrawal.
