Traditional IRA vs. Roth IRA - Which is Better
By Joshua Kennon, About.com Guide
Question: Traditional IRA vs. Roth IRA - Which is Better
Answer: Deciding whether to open a Roth IRA or Traditional IRA is a major decision with potentially
large financial consequences. Both forms of the IRA are great ways to save for retirement, although
each offers different advantages.
Traditional IRA Profile
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Tax deductible contributions (depending on income level)
Withdraws begin at age 59 1/2 and are mandatory by 70 1/2.
Taxes are paid on earnings when withdrawn from the IRA
Funds can be used to purchase a variety of investments (stocks, bonds, certificates of
deposits, etc.)
Available to everyone; no income restrictions
All funds withdrawn (including principal contributions) before 59 1/2 are subject to a 10%
penalty (subject to exception).
Roth IRA Profile
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Contributions are not tax deductible
No Mandatory Distribution Age
All earnings and principal are 100% tax free if rules and regulations are followed
Funds can be used to purchase a variety of investments (stocks, bonds, certificates of
deposits, etc.)
Available only to single-filers making up to $95,000 or married couples making a combined
maximum of $150,000 annually.
Principal contributions can be withdrawn any time without penalty (subject to some minimal
conditions).
Tax Deferred vs. Tax Free
The biggest difference between the Traditional and Roth IRA is the way the U.S. Government treats
the taxes. If you earn $50,000 a year and put $2,000 in a traditional IRA, you will be able to deduct
the contribution from your income taxes (meaning you will only have to pay tax on $48,000 in income
to the IRS). At 59 1/2, you may begin withdrawing funds but will be forced to pay taxes on all of the
capital gains, interest, dividends, etc., that were earned over the past years.
On the other hand, if you put the same $2,000 in a Roth IRA, you would not receive the income tax
deduction. If you needed the money in the account, you could withdraw the principal at any time
(although you will pay penalties if you withdraw any of the earnings your money has made). When
you reached retirement age, you would be able to withdraw all of the money 100% tax free. The Roth
IRA is going to make more sense in most situations. Unfortunately, not everyone qualifies for a Roth.
A person filing their taxes as single can not make over $95,000. Married couples are better off, with a
maximum income of $150,000 yearly.
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Is there any way to avoid the 10% early withdrawal penalty on my IRA?
Yes! There are ways to avoid paying early withdrawal fees. You can read about the eight exemptions
to IRA early withdrawal penalties in another section of the Beginner's Corner. (This article is part of
this reading . You can find it on pages 3-4).
Where can I open an IRA?
IRA's of both types can be opened through a bank or brokerage house. If you are interested in holding
stocks or bonds in your IRA, it may be wiser to open an account with your broker. It should require no
more than a few minutes' visit to the local branch office, or a trip to their website.
How much money do I need to open an IRA?
Minimum opening fees differ by institution, but are dramatically less than other types of investment
accounts.
How much can I contribute to my IRA each year?
You can see a chart of allowable contributions year-by-year in the IRA Subject Menu. (this chart is
included in this reading beginning on page 5).
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Eight Ways to Avoid the 10% Early Withdrawal Fee on
Your IRA
By Joshua Kennon, About.com Guide
Many IRA owners are aware they can be hit hard with penalty fees if they withdraw money early.
Fortunately, there are ways to avoid these fees if an emergency or other qualifying situation arises.
Before we begin, let me say that even with these allowances, you should make every effort to avoid
taking money out of your retirement accounts early, especially if you are young. By withdrawing
money, you are losing decades of tax-free compounding which can cost you hundreds of thousands of
dollars by the time you retire.
1. Permanent disability of IRA owner
Money can be withdrawn without penalty in the event the IRA holder becomes permanently disabled.
2. Death of IRA owner
It's small consolation, but if you kick-the-bucket before you're 59 1/2 years old, your estate won't be
hit with the 10% early withdrawal fee.
3. Withdrawals are used to pay non-reimbursed medical expenses
In the event of serious illness or injury that requires prolonged or expensive medical treatment, Uncle
Sam will waive the early withdrawal fee on the condition that the expenses are in excess of 7.5% of
your adjusted gross income.
4. Withdrawals used to help pay for first-time home purchase
Despite a lifetime limit of $10,000, this exemption can make it much easier for an IRA owner to buy a
house.
5. Higher education costs
College can be expensive. Thankfully, certain higher education costs for you, your spouse, children or
grandchildren can be withdrawn penalty-free. You may still owe federal income tax, however. For
more information, read the Internal Revenue Service article Notice 97-60 Using IRA Withdrawals To
Pay Higher Education Expenses.
6. Money is used to pay back taxes to the IRS after a levy has been placed against the IRA
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This is not the kind of exemption for which you want to qualify, but it may save you money if you find
yourself in an uncomfortable position with the IRS.
7. Withdrawals used to pay medical insurance premiums
Out of a job? The rest of the world may be topsy-turvy, but rest assured, you won't be penalized for
using retirement money to pay your medical insurance as long as you have been on unemployment
for longer than twelve weeks.
8. Made on or after the day the IRA owner turns 59 1/2
Once you have reached the qualifying age of 59 1/2, you can make penalty-free regular withdrawals
upon which to live.
A Caveat
There is one catch to these qualifying exemptions; the holder of an IRA is subject to a five year
waiting period (measured in tax, not calendar, years). An investor could not, for example, deposit
$3,000 in their IRA this year and withdrawal it next year penalty-free even if it would otherwise
qualify as an exemption.
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Traditional IRA and Roth IRA Contribution Limits
By Joshua Kennon, About.com Guide
Regardless of the type of IRA you choose, the Federal government imposes annual contribution limits.
The chart below shows the maximum dollar amount individuals are allowed to deposit into their IRA
each year. After 2010, the contribution limit will raise in increments of $500 depending upon the level
of inflation.
Deposits into your IRA do not have to be made at the same time. (For example: In the year 2010, a
35 year old woman could deposit $416.67 into her IRA each month. At the end of the year, it would
add up to the maximum $5,000.)
Due to the tax advantages of investing through an IRA, it is normally best to try and make the
maximum annual contribution. The use-it-or-lose-it nature of contributions makes this all the more
important (e.g., If you deposit $3,000 in 2009, you can't deposit $7,000 in 2010 [the $5,000 + the
$2,000 you didn't deposit the prior year]. You cannot contribute more than the total allowable amount
during any fiscal year.)
For more information, read our Guide to Retirement Account Contribution Limits. You can also visit our
special, 101 Things Every New Investor Should Know About Stocks.
IRA Contribution Limits
YEAR
AGE 49 & BELOW
AGE 50 & ABOVE
2002-2004
$3,000
$3,500
2005
$4,000
$4,500
2006-2007
$4,000
$5,000
2008
$5,000
$6,000
2009
$5,000
$6,000
2010
$5,000
$6,000
2011
$5,000
$6,000
2012
Indexed to Inflation
Indexed to Inflation
2013
Indexed to Inflation
Indexed to Inflation
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