Converting to a Roth IRA

Editor's note: As a special feature for April, TheStreet.com is offering a seven-part series on maximizing your IRA. This installment is Part 2. Click here for Part 1, Part 3, Part 4, Part 5, Part 6 and Part 7.

Let's assume that you like the idea of saving for retirement and using a tax-deferred or tax-free method of doing so. Let's further assume that you are married, that you and your spouse are both around 40 years old, and that your total income is less than $150,000 per year. Which IRA, traditional or Roth, would be better?

First we'll discuss the basic differences. Contributions to a traditional IRA are tax-deductible in the year made. That means that our hypothetical couple can reduce their adjusted gross income by $8,000 by making the maximum contributions to their individual IRAs. If they are in the 25% tax bracket, then they will save one-quarter of the total contributed, or $2,000, on their taxes due for the year. Therefore, in addition to that savings, they only need $6,000 to fund their contributions.

There are a couple of negatives here, however. Uncle Sam requires that taxes be paid eventually and, in the case of the traditional IRA, these taxes will be paid when withdrawals are made, usually in retirement years over the age of 59 1/2. There are penalties associated with making early withdrawals (usually 10% of the amount withdrawn), but these penalties are waived in certain circumstances, such as the taxpayer becoming disabled, various financial calamities or when the withdrawal is being used to make a first-time home purchase.