Congress has flooded us with Individual Retirement Account tax shelters without a road map. Maybe the toughest decision is to choose between the traditional IRA and the new Roth. The problem is, the rules are confusing and have no recognizable logic.
Comparing the advantages is easy. The traditional IRA usually gives the taxpayer a deduction for contributions upfront and then taxes the withdrawals while the Roth gives no deduction on contributions, but does not tax earnings.That's simple enough. But hold on, there's more:
- Eligibility: The first question in making the decision is, Are you eligible for both? With a Roth, your adjusted gross income must be less than $95,000 for singles and $150,000 for joint filers. To qualify for the traditional plan, you must not participate in a company retirement plan or if you do, you must have income of less than $35,000 for singles and $50,000 for joint filers.
If you are eligible for both, choosing between the two depends on your predictions. Will you be in a lower tax bracket when you pull out the money? Do you plan to sock the money away for a long time? Here are some considerations:
- Lower tax bracket at withdrawal: When taxpayers think they will withdraw while in a lower bracket than at the time of contribution, then a traditional IRA may be better.
They will benefit from a high tax rate on a deduction and be subject to a low rate on income. With some, it may be easy to decide, with others impossible. How can you know what your tax bracket will be 25 years from now - or even next year?
- Delaying withdrawal for a long time: With both, an early withdrawal may trigger a 10 percent penalty unless the funds are taken out after age 59 1/2, death or disability, or a need of up to $10,000 to buy a new house.