Roth vs. Regular IRAs

Which one is best for you? That depends on your age and income.
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The following is a transcript of " Money Girl's Quick and Dirty Tips for a Richer Life," a podcast from QuickAndDirtyTips.com. The audio program is available via RSS feed here and at TheStreet.com's podcast home page.

Hello and welcome to

Money Girl's Quick and Dirty Tips for a Richer Life.

Today's topic: Roth or regular?

A listener named Cindy called in with this question:

Hi Money Girl. My name is Cindy and I'm calling about IRAs. My father-in-law always tells me to invest in a Roth IRA. Rather, I would prefer investing in a traditional IRA because I can take the tax break. And, I always figure that when I get older, I'll be in a lesser tax group than I am now. So I'm wondering what's better, a Roth IRA or a traditional IRA. Thank you.

Thanks for the question, Cindy.

To start off, let's take a quick look at the differences between a Roth and a traditional IRA, which (by the way) stands for Individual Retirement Arrangement. That's right! The "A" stands for "arrangement" not "account."

Tax Free vs. Tax Deferred

With a Roth, you contribute after-tax money, but your earnings get to grow completely free of federal tax, which is a

big benefit

. And, you pay no federal tax whatsoever on withdrawals, if you've had the Roth for five years or longer and are at least age 59 1/2.With a traditional IRA, your earnings grow

tax-deferred

, not tax free, which means they're taxed at your ordinary income tax rate when you withdraw them in retirement. There are two types of traditional IRAs: deductible and non-deductible. If you're eligible for a deductible IRA, the money you contribute is not taxed until you withdraw it.

So how do you decide whether a Roth IRA or a traditional IRA is right for you?

First, determine whether you're eligible to contribute.

Roth IRAs

To contribute to a Roth in 2007, your modified adjusted gross income must be $99,000 or less if you're single. And, if it's between $99,000 and $114,000, you can make a partial contribution.

If you're married and file jointly, your modified adjusted gross income must be $156,000 or less to contribute to a Roth. For incomes between $156,000 and $166,000, you can make a partial contribution.

Traditional IRAs

With a traditional IRA, on the other hand, anyone can contribute. However, if you meet the income requirements, you won't have to pay tax on the money you contribute until you withdraw it. If you're single and your modified adjusted gross income is $52,000 or less in 2007, you may deduct your entire contribution. If you're married filing jointly, you may deduct your entire contribution if your income is $83,000 or less. If your income is higher than these limits, you may still be able to deduct a portion of your contribution.(1)

Nonworking spouses may fully deduct their traditional IRA contribution if their modified adjusted gross income is $156,000 or less in 2007. So if you don't work, but your spouse does, you may contribute to a traditional IRA and deduct it, if your spouse is under this income limit.

Which One Is Right for You?

If you cannot deduct contributions to a traditional IRA and are eligible for a Roth, your decision is easy: you're much better off going with a Roth. The Roth is better because both withdrawals and profits are tax free. You pay taxes on your contributions up front, but that's it. It's completely tax free from there.

But if, like Cindy, you are eligible to deduct traditional IRA contributions, how do you decide whether to go with a deductible IRA or a Roth?

Here are some tips to help you decide:

Go with a deductible IRA if you're older, and if you need the tax deduction now or think you'll be in a lower tax bracket in retirement. A deductible IRA makes sense if you're older and, therefore, have a shorter time to benefit from the attractive tax-free growth of a Roth. With a deductible IRA, you avoid paying taxes on your contributions today, but you get stuck with a tax bill on your contributions and profits when you withdraw.

If you're younger or think your tax rate will be higher in retirement than it is today, go with a Roth. You have to pay tax on your contributions today, but your profits grow tax free, which can really help increase the future value of your retirement investments. In addition, you'll have retirement income that's free of federal tax.

There are also some additional advantages of going with a Roth:

  • With a Roth, you can withdraw your contributions at any time without paying tax or a penalty.
  • And, you can leave your money in a Roth as long as you want. There's no mandatory withdrawal age. With a traditional IRA, you must begin taking withdrawals after age 70½.

High-Income Earners, Listen Up

If you're a high-income earner and are not eligible to contribute to either a deductible IRA or a Roth, consider contributing to a nondeductible IRA for the tax-deferred growth. And, if you're a high-income earner and want to find out how you can convert your traditional IRA to a Roth, check out

Episode 28 of my podcast. You'll be able to convert in the year 2010.

How Much Can You Contribute?

So how much can you contribute to an IRA? You can contribute a maximum of $4,000 in 2007 (plus an additional $1,000 if you're 50 or older). If you're married and file jointly, you and your spouse can each contribute up to $4,000. In 2008, the limit will increase to $5,000.

I've posted a link to an IRA calculator below. You can use it to find out which type of IRA is best for you.

Cha-ching! That's all for now, courtesy of Money Girl, your guide to a richer life.

As always, everyone's situation is different, so be sure to consult a tax or financial advisor before making important financial decisions. This podcast is for educational purposes only and is not intended to be a substitute for seeking personalized, professional advice.

(1) Partial deduction rules for traditional IRAs: For 2007, you can deduct part of your contribution if you're single and your modified adjusted gross income is between $52,000 and $62,000 or if you're married filing jointly and your income is between $83,000 and $103,000. In addition, working and nonworking spouses who are not covered by an employer-sponsored plan may partially deduct their contribution if their modified adjusted gross income is between $156,000 and $166,000.

Related link:

Roth vs. Traditional IRA Calculator

Elizabeth Carlassare is the creator of the

Money Girl podcast. A business and technology writer, investor, and former mortgage loan officer, she has a long-standing passion for helping people make the most of their money. She is the author of the Internet business book, "Dotcom Divas," and has been interviewed on more than 60 regional and national radio programs, and featured on C-SPAN Book TV. Elizabeth holds an M.S. from the University of California, Berkeley. She has spoken internationally on the topic of women's entrepreneurship and access to capital. To request a topic or share a money tip, send an email to money@qdnow.com or call 877-6-RICHER.