Self-directed individual retirement accounts--those that you can open yourself--fall into two categories, traditional IRAs and Roth IRAs. Both may offer consumers desirable tax advantages. But traditional and Roth IRAs, although markedly similar on first blush, vary distinctly in terms of flexibility, specifically at what age you can make the best use of them.
Contributon Limits
Both traditional IRAs and Roth IRAs are subject to yearly contribution limits as set forth by federal law. These limits are adjusted for inflation as needed and may change in any given year. In 2010, the IRS indicated that the contribution limit for both types of IRAs is $5,000 if you were 50 years of age or younger at the end of 2009; and $6,000, if you were 50-years-old (or older) before 2010. Investopedia, the consumer website run by Forbes, indicates that you can have both a Roth IRA and a traditional IRA. You may split the amount of your maximum contribution between the two accounts.
Tax Advantages
CNN Money points out that the biggest difference between a traditional IRA and a Roth IRA is the time at which your investment is ultimately taxed. If you have a traditional IRA, you may be able to deduct some if not all of your contribution amount at the end of the tax year. Once you begin withdrawing from a traditional IRA, then you pay taxes on the money. With a Roth IRA, you don't get an initial tax break for making contributions. However, when you do make withdrawals from your Roth IRA, they are not taxed (provided you wait until the age at which you can receive qualified distributions).
Eligibility Requirements
Traditional IRAs and Roth IRAs have requirements as to who can make contributions. Up until the year you turn 70.5, you can contribute to a traditional IRA. However, if you have a Roth IRA, you can continue to contribute to it for the rest of your life. Those who have a high modified adjusted gross income (AGI) may not be eligible to contribute to their Roth IRA in a given year. The Internal Revenue Service indicates, per 2010 guidelines, those cannot contribute to a Roth have a modified AGI that is at or more than: $177,000 if married filing jointly or a qualified widower or widow; $10,000 if married filing separately and lived with a spouse at any time during the year; and $120,000 if married filing separately, single or head of household and the two spouses did not live together at any time during the year.
Distributions
The magic age at which you can receive qualified distributions from both types of IRAs is 59.5. However, if you have a traditional IRA, you are required to receive minimum distributions at age 70.5 (remember that you cannot continue to contribute to the IRA after this age). If you receive distributions before the age of 59.5, you'll not only be taxed on the income but pay a 10 percent penalty.
There is no minimum age at which you are required to receive distributions if you have a Roth IRA. You can also withdraw your contribution amounts at any time penalty-free; however, if you begin to dip into your earnings before age 59.5, you are subject to a 10 percent penalty. The IRS permits you to withdraw both contributions and earnings without penalty under certain circumstances, such as if you become disabled or decide to go back to college.
Pros and Cons
For those who are precluded from investing in a Roth IRA due to their level of income and filing status, a traditional IRA may be a necessary option. However, traditional IRAs may not offer the upfront tax advantage that some may think. As CNN money points out, whether you get a tax break from having a traditional IRA depends on your income, filing status, if you or a spouse is covered by a retirement plan at the workplace, and if you receive Social Security benefits. For example, the IRS indicates that if you make $177,000 or more, your filing status is "married filing jointly" and your spouse has a retirement plan through his or her workplace, you cannot deduct your contributions. Nor is it beneficial to rely on a traditional IRA to give you a tax deduction if you file as single or head or household, have a retirement plan through your employer and have a modified AGI of least $66,000.
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