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Boomer dilemma: Traditional or Roth IRA

Retirement Guide: Senior man standing by clear lake and mountains
Highlights
  • IRAs are a tool to save for retirement, but which is best?
  • The question is how you want to be taxed -- before or after retiring.
  • Your income in retirement could be a factor in choosing your IRA.

If you're a baby boomer trying to save for retirement, the decision between investing in a traditional or Roth IRA isn't easy. For most middle-income taxpayers, traditional IRAs offer a tax deduction and tax-deferred growth, while Roth IRAs are funded with after-tax dollars but offer tax-free growth and tax-free distributions in retirement.

Whether you're in your 40s or 50s, you're in a period of life when you need to maximize your retirement savings. When making the choice between traditional and Roth IRAs, there are issues to ponder, such as your current and future tax bracket, whether the IRS will permit you to deduct contributions, the current state of your retirement savings and whether you have a retirement plan at work.

If you qualify, the tax deduction allowed by the IRS for a traditional IRA is an enticing perk. Whether you qualify depends on your income and whether you are covered by an employee retirement plan. If you make the maximum allowed contribution of $5,000, or $6,000 for those who are 50 or older, and it's fully deductible, you deduct that amount from your income on your tax return, reducing your overall taxable income.

Taxes are a particularly vexing part of this decision-making process. The direction of future tax rates is important, but they are impossible to predict. Even trying to figure out whether your tax rate in retirement will be lower than it is now isn't easy.

"So often, people think in retirement that they are going to need X amount of money per year and (wonder whether) their investments (will) be able to generate that amount per year," says Lisa Featherngill, a financial adviser with Calibre Family Office Services in Winston-Salem, N.C.

The ABCs of IRAs

IRAs allow you to put away $5,000 into a retirement savings account where the funds will accumulate on a tax-deferred basis. If you're 50 or older, you can contribute an extra $1,000 per year. IRS rules allow you to split those funds between a traditional IRA and a Roth IRA as long as you meet income guidelines.

Here are the basics of each type of IRA:

Traditional IRA

Deductible: Your contributions are tax-deductible. Your funds will grow tax deferred, but you must pay taxes on your contributions when you withdraw them at retirement. IRS rules mandate that you begin taking distributions from your traditional IRA the year after you turn 70½, although this rule was waived on a one-time basis for 2009. The size of those distributions depends on your life expectancy and your spouse's life expectancy, if you are married.

Nondeductible: If your income is too high to contribute to a tax-deductible IRA, you can contribute to a nondeductible IRA. Unlike the more common IRA, your contributions to this type of IRA are not tax-deductible. You can mingle nondeductible contributions with deductible contributions, although the IRS requires you to track the amount of your nondeductible contributions. This is important when you begin to make your required minimum distributions from your IRA because you won't have to pay taxes on the nondeductible portion. This can get complicated, and taxpayers who do this need to keep good records of their various types of contributions.

Roth IRA

Your contributions to a Roth IRA are not tax-deductible. Distributions from a Roth are tax-free when you withdraw funds in retirement, as long as you own the account for five years and withdraw the money after age 59½. Roth IRAs require no minimum distributions. And beginning in 2010, you can convert to a Roth IRA regardless of your income. Bankrate's video explains Roth vs. traditional retirement account options.

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