WITH THREE FLAVORS to choose from — Roth, deductible or nondeductible — figuring out which IRA is best for you can be confusing. So let us make this simple: If you qualify for a Roth (see table below), this is almost always the way to go.
That said, let us reiterate that if your employer offers a 401(k) plan with a match, you should always max it out before considering any type of IRA (see How to Make the Most of Your 401(k)). But after that, a Roth will typically give you the best bang for the buck. The applet below will let you see for yourself. It compares the potential gains in a Roth, a nondeductible IRA and a tax-deductible account.
Why is a Roth better? Unlike traditional IRAs (both tax-deductible and nondeductible), withdrawals from Roth IRAs after age 59 1/2 aren't generally taxed. You pay your taxes on the front end by contributing after-tax dollars. So Roth IRAs enable savers who remain in the same income tax bracket at retirement to accumulate more money than even tax-deductible IRAs do.
They're also more flexible. With a Roth, you can withdraw contributions (but not gains) for anything you want, penalty- and tax-free. College, home down payments, expenses related to a disability — you name it. The one big restriction is that you'll generally have to wait five years to withdraw conversion contributions from a traditional IRA.
The only problem with a Roth is that you might not qualify. Who does? Joint filers with modified adjusted gross income, or MAGI, below $160,000, and individuals with MAGI below $110,000. (Eligible contributions start to phase out at $150,000 for joint filers and $95,000 for individuals.)
If you do qualify for a Roth, you can make annual contributions of $4,000 a person ($4,500 if you will be age 50 or older at year-end). And if your modified adjusted gross income is under $100,000, you can also convert money from traditional IRA accounts into a Roth. You'll have to pay taxes upfront, but over the long term, you'll probably end up earning a lot more. For more on how conversions work, see Roth IRAs: To Convert or Not.
The IRA Buffet
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TAX-DEDUCTIBLE IRA |
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Who's Eligible
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In tax-year 2005, eligibility phases out for individuals with MAGI between $50,000 and $60,000 and for married couples with MAGI between $70,000 and $80,000* (for 2004, between $45,000 and $55,000
for singles, between $65,000 and $75,000 for couples). No income cap for individuals not covered by an employer-sponsored retirement plan or for married couples when neither participates in such a plan. If only one spouse participates in an employer-sponsored plan, IRA eligibility phases out between MAGI of $150,000 and $160,000 for uncovered spouse, between $70,000 and $80,000 for covered spouse ($65,000 and $75,000 in 2004). If covered spouse files separately, phase out is between $0 and $10,000.
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| Annual Contribution |
$4,000 tax-deductible ($4,500 if you are age 50 or older at year-end). |
| Withdrawals |
Withdrawals taxed as income. Penalty-free withdrawals permitted before age 59 1/2 for first-time home purchase up to $10,000, higher education expenses or in event of disability or death. |
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ROTH IRA |
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Who's Eligible
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Eligibility phases out between MAGI of $95,000 and $110,000 for singles, and $150,000 and $160,000 for married couples.
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| Annual Contribution |
$4,000 not tax-deductible ($4,500 if you are age 50 or older at year-end). |
| Withdrawals |
Tax-free and penalty-free withdrawals of earnings plus contributions after five years if you are 59 1/2 or in the following circumstances: death, disability or for first-time home purchase up to $10,000. Penalty-free, but not tax-free withdrawals permitted before age 59 1/2 for higher education expenses. |
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NONDEDUCTIBLE IRA |
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Who's Eligible
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Everyone who has earned income.
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| Annual Contribution |
$4,000 not tax-deductible ($4,500 if you are age 50 or older at year-end). |
| Withdrawals |
Withdrawals of earnings taxed as income. Penalty-free withdrawals permitted before age 59 1/2 for first-time home purchase up to $10,000, higher education expenses or in event of disability or death. |
*These income caps will increase to $80,000 for couples by 2007.
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With a Roth, you can withdraw contributions for anything you want, penalty- and tax-free. College, home down payments, expenses related to a disability — you name it.
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