Saturday, January 30, 2010

ROTH vs. Traditional IRA


Authored by David Cash, CPA, MAcc. Dave has worked in both offices of CMP. He spent 2 years in the Logan office and has been in the Salt Lake office for 3 years. Dave specializes in oil and gas taxation, and individual and business tax planning and compliance.

 
When a taxpayer is not offered a retirement plan through their work place many taxpayers that still want to save for retirement are faced with one major decision…what type of IRA do I want?

 
As with most questions in the world of taxation, this is a question that can only be answered by "It depends."

 
It depends on the personal situation of the taxpayer and what expectations they have for the future. Let's start with the major difference between these two types of IRA:

 
A ROTH IRA is one where the contributions are taxed, but the earnings can be tax free.

 
A Traditional IRA is one where the contributions are deductible, but when the money is distributed from the IRA then the entire distribution is taxable.

 
Taxpayers that would be ideal to chose the ROTH IRA would be someone:

  1. That is younger (more years for earnings to grow in the IRA),
  2. That may need to use the contributions prior to age 59 ½ (contributions can be withdrawn tax free prior to age 59 ½)
  3. In a low tax bracket (a bet that they will be in a higher tax bracket when they withdraw the money tax free), or
  4. Someone that doesn't expect to need the money in retirement (maybe you will get a big inheritance and you want your savings to go to your heirs and you don't want to have Required Minimum Distributions).
Taxpayers that would be ideal to chose the Traditional IRA would be someone

  1. That is in a higher tax bracket (needs or wants the tax deduction now),
  2. Someone that actually wants to save the money for retirement (most distributions prior to age 59 ½ are subject to a 10% early withdrawal penalty)
  3. Someone whose income exceeds the limit to be allowed to contribute to a ROTH IRA (for 2010 people who file Married Filing Joint can't contribute to a ROTH if their Modified Adjusted Gross Income is over $177,000), or
  4. Someone who expects their tax bracket to be lower when they retire (you don't want to pay tax at 35% when you may be able to pay tax at 10% when you retire).

There are many aspects to consider when deciding what type of IRA is best for you. The biggest reason why most accounting questions, including this one, are answered with "It depends" is that what may be best for you may not be best for your next door neighbor. People and situations are different and in the world of retirement contribution options one size does not fit all.

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