Name: Eric
Question: I've now been working in the real world a few years and am just getting to the point where I'm able to put some money away for savings, should I be putting my money in a traditional IRA or roth?
Answer:
Hi Eric, first of all it's great to hear that you're starting to think about your savings. For those people that may not know, an IRA is an Individual Retirement Account. IRAs provide either a tax-deferred or tax-free way of saving for retirement.
For 2009 the Roth and Traditional IRA contribution limit is $5,000. However, if you will be 50 or older by the end of the year, you can contribute an extra $1,000, for a $6,000 total contribution limit.
Income must be considered when choosing an IRA. You can have unlimited income and contribute tax-deferred earnings into your Traditional IRA. The same is not true of a Roth IRA. I'll give you an example for a married couple first... Married individuals who file jointly can contribute $5,000 ($6,000 if 50 or older) to a Roth IRA if theirgross income is below $166,000. If they earn between $166,000 and $176,000, then they can contribute some amount less than their full limit, depending on actual gross income. If their income exceeds $176,000, they are not eligible to contribute to a Roth IRA for 2009. For single individuals, the Roth IRA phase-out limit is lower: $105,000 to $120,000 for 2009. So if you're a corporate exec then don't worry about opening that Roth.
Check out this Roth IRA vs. Traditional IRA Calculator that State Farm provides and you can even enter in some scenarios to find out which will work best for you.
Whatever you contribute towards your Traditional IRA can be deducted off your yearly income, therefore reducing the amount of taxes you pay. However, once the money in a Traditional IRA is withdrawn, it is subject to standard income taxes and an additional 10% penalty if withdrawn before the age of 59 1/2. An exception is made if the money is used to buy a house or for educational purposes.
Roth IRAs are not tax-deductible, but contributions can be withdrawn at any time without being subject to penalty or tax, though interest earned in the account is. After five years, both contributions and earnings in the account can be withdrawn without penalty or taxation. Same thing with housing and education for the Roth.
My personal choice for most individuals not earning more than $105,000 is a Roth IRA. This way all interest, dividends, and capital gains can grow tax free. No taxes when you withdraw! This is extremely beneficial if your portfolio does well. Let's say you have some stocks that double or even triple, with a Traditional IRA you'd have to pay taxes on the gains... but with a Roth it's all yours to keep. If you're young and planning on being in the market for 20, 30 or even 40 years then don't hesitate to start that Roth IRA. Contribute AS MUCH AS YOU CAN! Try and get to that $5,000 mark because it will pay huge benefits in the long run. If you start contributing the max $5,000 per year now...and keep that up for 30 years... and have an 8% rate of return you'll be sitting on over $611,000.00!!! Thanks for the question, start throwing that money in a Roth!
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