Personal Finance Best Practices

Traditional IRA vs. Roth IRA

Which One Is Right for You?
Provided by John Hamerlinck, UBS Financial Services Inc.

Whatever you see for yourself in retirement – whether it’s work, leisure or something in between – you’ll need sufficient funds to ensure yourself an adequate income on which to live. It used to be that most people could rely solely on employer-sponsored pension plans and Social Security payments to provide for a comfortable retirement. Not so today!

More people than ever are responsible for planning and funding their own retirement, and one of the most effective and popular retirement savings vehicles is the individual retirement account (IRA). This article provides an overview of two different types of IRAs – the traditional IRA and the Roth IRA.

The Traditional IRA

Your savings in a traditional IRA get the benefit of tax-deferred growth until those savings are withdrawn. Contributions may or may not be tax-deductible depending upon your income level and whether you (and your spouse, if married) are covered by an employer’s qualified retirement plan (see below).

If you are a working individual under the age of 70½, you are eligible to contribute 100% of your earned income, up to $4,000 in 2007, to a traditional IRA. If you are age 50 or older, you can make an additional $1,000 catch-up contribution for the year. Single income married couples may contribute 100% of earned income up to $8,000 for 2007 (plus catch-up contributions, if eligible), although no more than $4,000 ($5,000 if age 50 or older) can be contributed on behalf of any individual each year.

Contributions to a traditional IRA have always been, and remain, tax deductible for:

• Single taxpayers who are not covered by such an employer-sponsored qualified retirement plan, and

• Married couples filing jointly where neither spouse is covered by such an employer-sponsored qualified retirement plan.

Deductibility for individuals who are covered by an employer-sponsored qualified retirement plan depends on adjusted gross income (AGI).

IRA contributions for 2007 are fully tax deductible for:

• Single taxpayers covered by an employer-sponsored plan, if their AGI doesn’t exceed $52,000 in 2007, and

• Married individuals covered by an employer-sponsored plan, whose joint AGI doesn’t exceed $83,000 in 2007.

Tax-deductibility is phased out as AGI rises above these limits.

For 2007, if one spouse is covered by an employer-sponsored qualified retirement plan and the other is not (whether a working or non-working spouse), the spouse who is not covered may deduct his or her IRA contribution, as long as the couple’s joint AGI doesn’t exceed $156,000. A partial deduction is allowed for those with AGI between $156,000 and $166,000. No deduction is allowed where the couple’s joint AGI exceeds $166,000. Investors who do not qualify to make tax-deductible contributions can still contribute up to the annual maximum for a particular year to a traditional IRA and benefit from the potential of tax-deferred growth. Withdrawals of tax-deductible contributions, as well as all earnings, are taxed as ordinary income (withdrawals made prior to age 59½ may also be subject to a 10% penalty tax).

The Roth IRA

The Roth IRA is similar to a traditional IRA in that earnings grow without being subject to current taxes. Eligible taxpayers may contribute up to $4,000 ($5,000 if age 50 or older) of earned income to a Roth IRA for each of 2006 and 2007. The annual limit applies in the aggregate, whether contributions are made to a Roth IRA, a traditional IRA, or a combination of the two. Contributions of earned income may be made to a Roth IRA on behalf of a spouse even if he or she has little or no earned income.

However the Roth IRA is different from the traditional IRA in several important ways:

• Contributions are made only with after-tax dollars (since contributions are made after taxes, they can always be withdrawn tax-free and penalty-free).

• Income eligibility phase-out limits for contributing to a Roth IRA for 2007 are $99,000 to $114,000 for single taxpayers and $156,000 to $166,000 for married taxpayers filing jointly.

• There are no required minimum distributions from the Roth IRA at age 70½ (as there are with a traditional IRA). Contributions can be made beyond age 70½, as long as there is earned income.

• Withdrawals of earnings can be made income-tax and penalty tax free if the account has existed for at least five tax years, and any one of the following conditions is met:
  
  1) Attainment of age 59½,
  2) Disability,
  3) The distribution is for the first time purchase of a home up to a lifetime limit of $10,000, or
  4) Death of the accountholder.

Converting a Traditional IRA to a Roth IRA

If you qualify, you may be able to convert your existing traditional IRA funds to a Roth IRA. This conversion of assets from a traditional IRA to a Roth IRA can only be done if the individual or married couple has AGI of no more than $100,000 for the year of the conversion and the taxpayer is not a married individual filing a separate tax return. In addition, it can only be done on an after-tax basis. Therefore, the account holder must pay ordinary income taxes on the portion of the traditional IRA that is taxable (i.e., deductible contributions and all earnings). Since a number of special rules apply, you should discuss this strategy with your tax advisor. (Please note that, beginning in 2010, the $100,000 AGI limit and the tax filing status requirement described above for Roth IRA conversions will no longer apply.)

Choosing the IRA That’s Right for You

Besides your AGI, there are a number of factors to consider before choosing between the traditional IRA and the Roth IRA. They include your age, number of years until retirement, growth rate earned on your investments, as well as your current and anticipated future income tax brackets. Generally, contributing to a Roth IRA can be more advantageous than making nondeductible contributions to a traditional IRA. The two accounts are treated similarly in the year a contribution is made (i.e., no deduction is allowed), but upon withdrawal, distributions from the Roth IRA are potentially tax-free, while taxes must be paid on the earnings portion of the distribution from a traditional, nondeductible IRA. If you are eligible to make both a deductible traditional IRA contribution and a Roth IRA contribution, your situation is even more complicated. Your financial advisor and tax advisor can assist you in conducting the necessary analysis to determine which type of IRA would help benefit your particular situation.

This article was provided by John Hamerlinck, financial advisor for UBS Financial Services Inc. Drawing on 20 years of management and financial experience John works with business owners and individuals that need sophisticated financial planning and investment strategies. He recently joined UBS Financial, one of the leading global financial firms. A former Marine Corps veteran he holds a MBA from Lewis University. You can contact John at 727-892-2516 or www.ubs.com/fa/johnhamerlinck.

This article is intended to provide a general discussion of traditional and Roth IRAs. Neither UBS Financial Services Inc. nor its financial advisors provide tax or legal advice. You must consult with an attorney or tax professional regarding your specific financial situation.

Published August 2007, Volume 1, Number 5, Bay Area Business Magazine

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