Roth vs Traditional: Choosing Your IRA Type

Physician's Money Digest, August 2007, Volume 14, Issue 8

IRAs have been a huge boom to retirement planning since their introduction in the 1970s. Created as a tool for workers without an employeesponsored retirement plan, IRAs soon became valuable for everyone because of the tax advantages. They are ideal for self-employed people like physicians who often don’t have a company-paid retirement plan. When people refer to IRAs, they generally are talking about one of two types—the traditional IRA or the Roth IRA. Both have tax advantages, but depending on your age, income, and other circumstances, one may be more advantageous than the other.

The biggest difference between traditional and Roth IRAs is the tax treatment of the money invested. With traditional IRAs, the money going into the account is deductible, and the earnings grow tax-deferred until withdrawn. With a Roth IRA, there is no deduction, but withdrawals are tax-exempt.

Income Limitations

To participate in a Roth IRA, single filers must have adjusted income of less than $99,000 and married filing jointly of less than $156,000. There are no income caps for traditional IRAs, but filers in 2007 with adjusted gross incomes of more than $52,000 for singles or $83,000 married filing jointly lose the ability to deduct the full amount of the annual contribution. The earnings still accrue taxdeferred, however. In both cases, the law has recently been changed to index these thresholds over time and allow "catch-up contributions"—larger contributions for individuals aged 50 and older. For 2007, the maximum contribution is $4000 per person, and individuals aged 50 and older can increase that by $1000.

In both cases, nonworking spouses can have an IRA in their name, providing additional tax benefits to a couple. And, it is important to remember that many different types of investment products can be used as an IRA, including mutual funds and CDs. So, you can fund your IRA with an investment that meets your investment goals and your tolerance for risk.

How to Choose

To calculate which type of IRA will generate more income for your needs, factor in your age, your tax bracket, the type of investment, and your expected rate of return. Free comparison calculators abound on the Internet, but beware that some may have built-in assumptions that don't apply to your situation or are overly simplistic. Katherine B. Paal, MBA, CFP ®, CTFA, is a Certified Financial Planner™ practitioner at Heritage Financial Consultants in Lutherville, Maryland, and is an investment advisor representative, registered representative, and licensed insurance broker with Lincoln Financial Advisors, a registered investment advisor and broker/dealer. She welcomes questions or comments at kpaal@LNC.com. This information should not be construed as legal or tax advice. You may want to consult a tax advisor regarding this material as it relates to your personal circumstances.