How To Compare Traditional IRA With Roth IRA?

The Roth IRA is a recent innovation (introduced in 1997) as compared to the traditional IRA. Any market survey would tell you that Roth IRA account is preferred over the regular traditional IRA and is widely used for both post-retirement economic security as well as investment purposes.

However, it is important to take a close look at the features of the two qualified retirement plans and arrive at an understanding about their differences and their advantages. This will considerably help you compare traditional IRA with Roth IRA.

To begin with, the Roth IRA eligibility for both are different. In a traditional IRA account, any earning individual (and his/her spouse if it is a joint account) below the age of 70 can opt for this retirement savings plan. Contributions to the traditional IRA are stopped after the age of 70 years. In the case of Roth IRA, there is no age bar for contribution; you can continue even after 70 years. But Roth IRA is available for only those whose annual income falls below a notified income slab. For 2007, the income slab (or the Adjusted Gross Income) is fixed at $114,000 for individuals and $166,000 for joint return filers. The income in both instances has to be less than the stipulated amount.

There is a limit to the maximum annual contribution in both the schemes. In the notifications issued for 2006-07, the maximum annual contribution to both Roth IRA and Traditional IRA account cannot exceed $4,000, if an individual is below the age of 50 years, and $5,000 if an individual is above the age of 50 years.

What differentiates the two types of IRA is their tax-deferred or tax-free nature. The contributions in the case of traditional IRA are fully deductible according to the federal income tax codes. These contributions can bring down the income on which you need to pay income tax. However, you end up paying these taxes at the time of withdrawal. In the case of Roth IRAs, the annual contributions are taxable. You need to pay taxes on them according to prevailing income tax rates. But unlike traditional IRAs, the withdrawal is completely tax-free. When you want to compare traditional IRA with Roth IRA, this IRA information must be considered.

The ceiling on annual contribution is fixed for both the schemes. There is a penalty of 6 per cent in case of excess contribution. Further, after the age of 59 years, the withdrawals from traditional IRAs would be subjected to prevailing income tax rates but such is not the case with Roth IRA. Withdrawals are tax-free. Further, in case of traditional IRAs, withdrawal is mandatory at the age of 70 years. Also, insufficient withdrawals would invite penalty of 50 per cent. In case of Roth IRAs you can continue making contribution until your death.

Withdrawing before stipulated time from traditional IRAs is taxable at the rate of 10 per cent. With Roth IRA you can withdraw tax free up to $10,000; and if the account is 5 year old then withdrawals are penalty free.