Roth versus Traditional IRAs
Feature Question for Tax Accountant:
Should I purchase a Roth IRA or a traditional IRA?
Answer: First, you should determine if you are qualified to make a contribution to either. You may make contributions to either traditional or Roth IRAs only to the extent you have earned income includible in gross income. You must be less than age 70 ½. The maximum contribution for a taxpayer and the taxpayer’s spouse is $3000 each for 2004. Individuals who are at least age 50 will be able to make an additional contribution of $500. You have until April 15th, 2005 to make an IRA contribution for the 2004 tax year.
In addition to the $3,000 limit mentioned above, contributions to traditional IRAs can be further limited when the individual (or spouse) is an active participant in a retirement plan maintained by an employer. The maximum deductible IRA contribution for an individual who is not an active participant, but whose spouse is an active participant, is phased out when modified adjusted gross income is between $150,000 and $160,000.
The maximum deduction for an individual who is an active participant in a retirement plan is phased out when modified adjusted gross income is between ($45,000 to $55,000 for single and head of household; $0 to $10,000 for married filing separate).
When both spouses are active participants in an employer sponsored retirement plan, deductible contributions are phased out when modified adjusted gross income is between $65,000 and $75,000. If your deduction is limited by the active participation rules, look to the Roth rules.
Roth IRAs are not subject to the active participation rules. However, contributions to Roth IRAs are phased out when income exceeds the thresholds. Contributions made by single filers are phased out when modified adjusted gross income is between $95,000 and $110,000, and for joint filers with modified adjusted gross income between $150,000 and $160,000, and for married filing separately with modified adjusted gross income between 0 and $10,000.
Roth and traditional IRAs also have different distribution rules, which goes beyond the scope of this article.
So if you qualify for both tradition and Roth, and you are not concerned with the different distribution rules, what is best? With traditional IRAs, you get an immediate tax deduction. Tax on your contribution is deferred until final distribution. Also, all earnings inside your traditional IRA grow tax deferred. Roth IRAs offer no immediate deduction. However, all earnings inside your Roth IRA grow tax free, not tax deferred.
Therefore, you must consider what tax bracket you are in now and what tax bracket you will be in when you receive the distributions. If you are in the 10 or 15 percent tax brackets, Roth may be a good choice. Based on a $3,000 contribution, you are bypassing immediate tax reduction of $300 to $450 in exchange for a lifetime of tax free accumulation on your $3,000 investment. This option looks even stronger if you expect to be in a higher tax bracket when you finally distribute your accumulation.
On the other hand, if you are in the 35 percent tax bracket, a Roth election means bypassing $1,150 immediate tax reduction (on a $3,000 contribution). If you expect to be in a lower tax bracket when you finally distribute your investment, as many retirees are, it makes sense to contribute to a traditional IRA and get an immediate tax break.
Call us if you need advise from a good tax accountant. We serve Seattle, Bellevue and the surrounding area.
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