Ask Dr. Don By Don Taylor, Ph.D., CFA • Bankrate.com

Roth vs. traditional IRA

Dear Dr. Don,
I have an IRA and am contemplating if I should put my monies into a Roth IRA. I don't really understand the difference between the two or their benefits.
Help!!
Maria Morass

Dear Maria,
The main difference between the two accounts is pretty straightforward. What's complex is determining which account is right for you. With a Roth IRA, you contribute after-tax dollars, and eligible distributions of investment returns (those not subject to penalty taxes) are tax-free. With a traditional IRA, you typically contribute pretax dollars and eligible distributions are subject to income taxes.

You can also convert a traditional IRA to a Roth IRA by paying income tax on the monies converted to the Roth IRA account. There are, however, income limits on who can convert the accounts.

Determining which type of IRA account is right for you depends largely on your current tax rates when contributing and the tax rates you expect to face in retirement when you receive distributions. If you are currently in a high tax bracket, the tax deferral feature of a traditional IRA is attractive. If you expect your tax bracket to be higher in retirement than it is today, then the Roth IRA is more attractive.

Eligibility:
Traditional -- you have earned income and you won't reach age 70½ by the end of the year.

Roth -- you have earned income and your modified adjusted gross income is $110,000 or less for single taxpayers, $160,000 or less for married filing jointly, $10,000 or less for married filing separately.

Contributions:
For both traditional and Roth, you may contribute up to $3,000 of earned income in 2004 ($6,000 for married couples.) Those age 50 or older can contribute up to $3,500.

Contributions to a traditional IRA are generally tax-deferred if you don't participate in an employer-sponsored retirement plan. Contributions to a Roth are never tax-deductible; they come from after-tax money.

Distributions:
Traditional -- Distributions taken after age 59½ are taxed as ordinary income. Distributions taken before 59½ are generally also assessed a 10 percent early withdrawal penalty. You must begin taking minimum required distributions by April 1 of the year after the year in which you reach age 70½.

Roth -- You never have to take distributions from your Roth. But you can begin taking them tax-free and penalty-free at age 59½ as long as the account has been open for five years.

Don't fall into an "analysis paralysis" trap and sit on the sidelines investing nothing for retirement because you can't make up your mind which type of IRA is best for you. If you can't decide, and are eligible to contribute to either type of IRA account, you can always choose the middle ground and split your contributions between the two types of accounts.

-- Posted: March 23, 2004