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As the name suggests, an Individual Retirement Account (IRA) can help you save and invest for retirement. Depending on which type you select, traditional or Roth, you'll receive certain tax and savings advantages—powerful tools to help you with your retirement goals. But as you'll see below, there are several differences between traditional and Roth IRA's. Learning about them can help you decide which is better for you.
For current contribution limits to both visit: IRS
|Required Minimum Distributions|
|Income Eligibility Limits|
Weighing the choice for those who can't decide which IRA is better: you may not have a choice.
If you aren't covered by a retirement plan at work and you have sufficient earned income to contribute to an IRA, you are always eligible to fund a Traditional IRA, no matter how much you make. But if you are covered by your employer's retirement plan, you may not be able to deduct all or any amount of your Traditional IRA contributions if your income is above the allowable threshold.
Meanwhile, with a Roth IRA, it doesn't matter if you are covered by a retirement plan at work. Instead, all that matters is whether your income falls below the threshold for eligibility.
Still, let's assume you need to choose between a tax–deductible IRA or a Roth account, either within your employer's plan or when making your annual IRA contribution.
If you expect your tax rate to be lower in retirement, then deductible retirement accounts, like the Traditional IRA, would provide you with a tax deduction today. If you are in a higher tax bracket at a later point in life a Traditional IRA can help putting off paying taxes until you are retired, at which point you may pay Uncle Sam at a lower rate.
Conversely, if you expect to pay taxes at the same or a higher rate once retired, you would pass up today's tax deduction with a Roth IRA to get what should be tax–free withdrawals in retirement.
What if you aren't sure? You could hedge your bets. Just as you can diversify your portfolio by purchasing a slew of different securities, you might also diversify your tax risk by funding both tax–deductible and Roth accounts.
While future tax rates often drive the tax-deductible vs. Roth decision, the Roth offers four additional advantages that you may want to consider.
You may discover that you aren't eligible for either a tax–deductible or Roth IRA. That means your only choice is a nondeductible IRA, which will still provide tax–deferred growth but no tax deduction. When you draw down the account in retirement, you will have to pay income taxes on the account's investment gains, though you won't owe taxes on the dollars you originally contributed. You may also want to consider whether converting some of your Traditional retirement accounts to a Roth IRA may benefit you.
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