There is a process that is important to go through when considering an IRA. First, let’s just look at a regular IRA. With a regular IRA, anyone that has income can invest into an IRA. However, there is a key question that you have to ask. Can I invest this money in an IRA and get a tax deduction?
For most people, it is the tax deduction of the contribution that is appealing about putting money into an IRA. The ability to deduct an IRA contribution comes down to two factors. First, are you an active participant in a 401(k) plan? If the answer is no, then you would get a tax deduction on the contribution. Second, what is your adjusted gross income?
If you are an active participant in a 401(k) plan, then the ability to deduct an IRA contribution comes down to the amount of money that you make. If you are married and filing jointly, you can deduct 100% of your IRA contribution as long as your adjusted gross income is below $83,000. Between $83,000 and $103,000, your ability to deduct is phased out. Over $103,000 AGI, you cannot deduct anything.
If you are single, the AGI limits are $52,000 to $62,000.
For the Roth IRA, it isn’t about the ability to deduct the contribution. It is about the ability to just contribute. If you are married and filing jointly, the income limits are $150,000 to $160,000. If you make less than $150,000, you can contribute the full amount. However, between $150,000 and $160,000, your ability to contribute starts to phase out. Over $160,000, you cannot contribute at all.
For the single filer, the income limits are $95,000 to $110,000.
Let’s say that you find yourself in that “unfortunate” position where you make too much money to contribute to a Roth. If that is the case, invest an after-tax contribution into your IRA. In 2010, they are lifting the income restrictions and allowing everyone, no matter your income, to convert traditional IRA’s into Roth IRA’s.
So for the next three years, you can put the maximum after-tax nondeductible contribution into the IRA and then convert it to a Roth in 2010.
So which makes the most sense? I believe that the Roth makes the most sense and it comes down to which gives you the biggest tax benefit. With a regular IRA you get the small tax deduction up-front. Then you pay taxes on the money once you take it out at retirement. With the Roth, you don’t get that tax deduction. However, when you take money out of the Roth it is all tax-free. You could have a tax-free income off of decades of investment growth. There is a huge difference in tax benefits.
The Roth also has one other big benefit. All contribution that you make to a Roth can be taken out of the account without penalty. If you get into a bind, you can take out your contributions.
Copyright © 2008 Prudent Money and Bob Brooks. All rights reserved.
