Choosing Between Roth Iras and Traditional Deductible Iras

Choosing Between Roth IRAs and Traditional Deductible IRAs

The decision is complicated if you're eligible for both types of IRAs. With the creation of the Roth IRA and the liberalized eligibility guidelines for the traditional IRA, the vast majority of individuals are now eligible to make some sort of IRA contribution.

IRA Eligibility

All but the wealthiest of workers are eligible to contribute to a Roth IRA. Eligibility to make the maximum contribution to a Roth is limited to married couples with adjusted gross incomes of less than $150,000 and single individuals with incomes under $95,000. Smaller contributions are allowed for couples with adjusted incomes up to $160,000 and singles with incomes up to $110,000. Roth IRA contributions aren't deductible, but withdrawals are tax-free once the account has been open more than five years and you're over age 59 1/2.

Fewer taxpayers qualify for traditional IRAs, where contributions are deductible, but withdrawals are taxed. But Congress loosened the eligibility requirements to allow many more taxpayers to take advantage of traditional IRAs than in the past.

The Taxpayer Relief Act of 1997 raised the income-eligibility limits for taxpayers who participate in a 401(k) or are covered by some other employer retirement plan. Before the rules were liberalized by the 1997 tax act, a married couple above the income-thresholds could make deductible IRA contributions only if neither spouse was covered by a retirement plan at work.

But this restriction was eased beginning with 1998 returns. If only one spouse is covered by an employer retirement plan, the other spouse will be eligible for at least a partial IRA deduction so long as the couple's joint income is below $160,000.

If neither spouse is covered by an employer retirement plan, then both spouses can make deductible contributions to a traditional IRA, no matter how high their income.

Roth IRA vs. Traditional IRA

The decision about which type of IRA to set up will be a simple one for most higher-income taxpayers who will only be eligible for Roth IRAs, but the decision is complicated if you're eligible for both types of IRAs.

There have been numerous articles in the financial press and advertising campaigns by financial institutions extolling the virtues of the Roth IRA. All the ballyhoo has made the advent of Roth IRAs seem like the financial equivalent of the Second Coming. And indeed, many people will find that the ability to make tax-free withdrawals from a Roth IRA is a more valuable tax benefit than getting an upfront deduction for contributions to a traditional IRA.

But many people won't come out ahead with a Roth IRA. Whether you're likely to come out ahead with the upfront tax deduction from the traditional IRA or the benefit of tax-free withdrawals from the Roth IRA depends on your tax bracket now, your expected tax bracket in retirement, how long you plan to keep the money in the IRA, and the return you expect from your investments.

If you opt for a Roth IRA, you should expect to be in at least as high a tax bracket - preferably a higher bracket - when you retire than you are in now. But many workers can expect to end up in a lower tax bracket when they retire, since most workers' incomes decline in retirement when they are no longer earning weekly paychecks.

How long you expect to keep the money in the IRA will also be an important