Back in a December 2010 blog post, we discussed budgeting and mentioned that one option was to open an IRA. However, there are two different types of IRAs, and deciding which one is best for you is extremely important.
While both Roth and Traditional IRAs currently have the exact same contribution limit ($5,000 in tax year 2010), contributions to Traditional IRAs are sometimes tax deductible, while Roth IRA contributions are never deductible. If neither you nor your spouse participates in an employer-sponsored contribution plan, you are allowed to deduct your entire Traditional IRA contribution for the tax year (up to a limit). If you and/or your spouse do participate in an employer contribution plan, there are several variables that will determine your deduction eligibility. IRS Publication 590 http://www.irs.gov/pub/irs-pdf/p590.pdf explains these variables, although you may wish to speak with a tax professional for a clearer answer for your particular situation.
Another difference between Traditional and Roth IRAs is that you cannot contribute to a Roth IRA if you make more than a certain amount of money. As a “single” tax filer, your modified adjusted gross income*currently must be under $120,000 and that of a married couple filing jointly must not exceed $177,000. There is no income cap on contributions to Traditional IRAs. However, after age 69 1/2, you are no longer allowed to make Traditional IRA contributions, while there is no age limit on Roth IRAs. Additionally, starting on April 1 the year after you turn 69 1/2, you are required to receive a certain amount of money from your Traditional IRA each year; even you do not need the money. This amount is treated as taxable income. Roth IRA distributions are not subject to income tax, as long as they are taken five or more years after the first contribution was made and the receiver is age 59 1/2, disabled, and/or buying a first home. If you are under age 59 1/2 and you need to withdraw funds from your Traditional IRA, you may be subject to an early-distribution penalty of 10% of the amount withdrawn. If you are unsure which IRA is best for your situation, be sure to speak with a tax specialist or financial adviser. You may even be able to split your contribution between both types, although your total contribution is still subject to the IRA contribution limit for each tax year.
*Your modified adjusted gross income is your adjusted gross income plus certain deducted items such as foreign income, foreign-housing deductions, student-loan deductions, IRA-contribution deductions, and deductions for higher-education expenses.
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