What’s Best: Roth or Traditional IRA?

With the April 15th deadline looming, you have a decision to make.  Should you invest in a Traditional IRA or would you be better off investing in a Roth IRA?  Remember that your investment in either must be postmarked no later than April 15, 2008 for a 2007 contribution.  In making your decision, let’s look at several key differences in the two retirement plans:


  1. Tax benefits.  One of the primary benefits you seek when investing in a Traditional IRA is a current tax deduction for your contributions.  Once invested, your traditional IRA funds grow tax deferred, meaning there is no taxation of interest, dividends or capital gains until the funds are withdrawn during retirement.  Withdrawals during retirement are taxed as ordinary income, presumably at lower tax rates.  With a Roth IRA your contributions are not deductible but qualified withdrawals are forever tax-free. 
  2. Contribution limits.  For 2007 the maximum contribution limit for either the Traditional or Roth IRA is $4,000.  If you turned age 50 during 2007, you’re eligible for an additional $1,000 catch-up contribution. 
  3. Phase-out provisions.  Your ability to take a deduction or make a contribution may be restricted based on your modified adjusted gross income or participation in an employer’s retirement plan.  With a Traditional IRA, if you were a participant in a company sponsored retirement plan in 2007, the deductibility of contributions phases out if your modified adjusted gross income is $83,000 – $103,000 for married couples filing jointly; $52,000 – $62,000 for single filers.  If you were not a participant in a company sponsored retirement plan in 2007 but your spouse was, the phase-out occurs between $156,000 – $166,000.  If you are single and were not covered by a company sponsored retirement plan in 2007, there is no phase-out.  With a Roth IRA, your ability to make a contribution is phased out as your modified adjusted gross income rises between $156,000 – $166,000; and for single filers $99,000 – $114,000.
  4. Distributions.  Beginning at age 70½ you must take Required Minimum Distributions (RMDs) from your Traditional IRA.  There is no such requirement for Roth IRAs.   The government imposes a 10% penalty for distributions taken from a Traditional IRA prior to age 59½.   With a Roth IRA, you may take distributions of the amounts you have contributed without penalty at any time.  Distributions of earnings are subject to a 10% penalty unless the Roth has been established a minimum of 5 years and you are at least age 59½.  Other exceptions apply. 

Whew!  Assuming you can follow all the rules and you are eligible to contribute to either a deductible Traditional IRA or a Roth IRA, how do you decide which is best?  The answer is impossible to know for sure because it’s impossible to predict future changes in tax laws as well as changes in your circumstances.  My rule of thumb is that if you are currently in the 25% or lower tax bracket, go with the Roth IRA.  If you are in the 33% or higher tax brackets, use the Traditional IRA so that you benefit from an immediate tax deduction.  The 28% tax bracket is the ‘swing’ bracket where you could go either way.