Individual retirement accounts (IRA) allow the account holder to plan for her own retirement her way. A person can choose to do so either with a traditional or a Roth IRA depending on her long-term goals. When selecting an IRA it is important to understand how the two types differ, the eligibility requirements for each as well as their limitations.
Contribution Limits
Traditional and Roth IRAs have similar contribution limits. In 2007 account holders could contribute a maximum of $4,000 into an IRA. The maximum contribution was increased to $5,000 in 2008 and has remained at that amount. Individuals over 55 are allowed to contribute an additional $1,000. This commonly is referred to as a "catch-up contribution." With both types of IRAs, individuals are not allowed to contribute more than they earn. Unlike a traditional IRA, however, individuals with Roth IRAs can continue to contribute to their account after they reach age 70. Traditional accounts have age limits.
Income Limits
Traditional IRAs do not have income restrictions or limitations, which means that anyone can open such an account. When it comes to a Roth IRA, on the other hand, a person's eligibility is tied to his income tax filing status and modified adjusted gross income. To qualify for a Roth IRA, a person's income must be less than $166,000 when married and filing a joint return; less than $10,000 when married, living with your spouse but filing separately; less than $114,000 for those filing as single, head of household or married filing separately; and anyone who did not live with a spouse during the filing year.
Tax Benefits
A traditional IRA differs from a Roth IRA in that any earnings and deductible contributions are tax deferred. Individuals do not have to pay taxes until the funds are withdrawn. Generally account holders withdraw their earnings upon retirement when they are in a lower tax bracket. The IRS may impose penalties if funds are withdrawn prematurely. Roth IRA contributions are taxed up-front. Any withdrawals will be tax-free for those individuals who have had an IRA for a minimum of five years and are at least age 59.
Tax Treatment of Distributions
How taxes are distributed is a major consideration when deciding which IRA--Traditional or ROTH--is best suited for you. In most cases distributions from a traditional account are considered "ordinary" income and may be subject to income tax. Early distribution penalties may be imposed if money is withdrawn before age 60. Conversely, ROTH distributions are free of taxes and penalties if the funds are withdrawn at least five years after an individual opens an account or the withdrawal is made because the account holder turns 59, is disabled, the account beneficiary receives any distributions upon the holder's death or the holder becomes a first-time home buyer.
Deductibility
When deciding between a traditional and a Roth IRA, consideration should be given to the account holder's eligibility to deduct traditional contributions in exchange for a tax break. An individual's eligibility depends on the person's tax filing and participation status and his income. In contrast, Roth contributions can never be deducted.
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