Traditional IRA vs. Roth IRA

There is alot to consider when deciding whether to fund a Traditional IRA or a Roth IRA. One of the simplest things to ask yourself is whether your tax bracket in retirement will be higher or lower than it is right now. That may be a difficult question to answer, especially if you are a long way from retirement. The reason that this is pertinent is that with a Roth IRA you will not be taxed on your withdrawals (as long as the Roth has been opened for over 5 years and you are older than 59 1/2-there are other qualified reasons that we will discuss later). With a traditional IRA you are taxed on your withdrawals. So if you anticipate your tax rate to be lower than it is currently, it would be beneficial to go with a traditional. However, if you believe that you will be in a higher tax bracket upon retirement, then the Roth would be the way to go since you will not be paying taxes on your withdrawals (as long as you meet specific requirements).
The following will give you an idea of the differences/similarities between the Traditional and Roth.

Traditional IRA
-Individual contribution limit per year $4000 (2006-2007), $5000 (2008-2010).
-Available to all individuals with earned income
-Fully deductible contribution if:
1. you and your spouse are not participants in an employee sponsored retirement plan for any part of the year.
2. you are not a participant, your spouse is, and your combined AGI (Adjusted Gross Income) is under $150k(married, filing jointly)
3. you are a participant and have a combined AGI that does not exceed $50-60k(single) or $80-90k (joint).
-Even if you and your spouse have an employee sponsored plan, you can still contribute, but it's not deductible.
-Earnings are tax deferred until withdrawn
-In general, withdrawals before age 59 1/2 are subject to ordinary income tax, plus a 10% penalty
-If early withdrawals are paying for new home expenses or qualified higher education costs, no penalty, you just need to pay ordinary income tax.
-Can convert your traditional IRA to a Roth IRA if your AGI is under $100k, you will however have to pay the taxes on the amount you convert.
-Mandatory distributions begin at age 70 1/2
-At your death, heirs pay income tax on distributions at their tax bracket.

Roth IRA
-Individual contribution limits per year $4000(2006-2007), $5000(2008-2110)
-Available to all individuals with earned income with the following income limitations:
for single filers, up to $95k (for full contribution) , $95-110k (partial contribution)
for joint filers up to $150k(for full contribution) , $150-160k(partial contribution)
-Contributions are not tax deductible
-Earnings grow tax free
-Contributions can be withdrawn at any time without tax or penalty (your first withdrawals will come from regular contributions)
-Withdrawals are taken in this order, regular contributions, any conversion contributions (tax consequences apply), and then earnings.
-Earnings are tax free after 5 years and after age 59 1/2 or other qualified requirements such as death, disability or first time home expenses.( the 5 year limit is based on January 1st of the 5th year after you open the account, therefore it could actually be less than 5 years) ex. open Roth in October '06, earnings will be tax free after January 1, 2011 as long as you are age 59 1/2.
-No mandatory distributions required at any age.
-Upon your death, if account is at least 5 years old, heirs will inherit income tax free
-Even if you participate in a plan at work, you can open a Roth subject to the income limits mentioned above.

There may also be the question as to whether it would benefit you to convert your traditional IRA to a Roth. Remember that you will have to pay the taxes on the amount that is converted to the Roth. A conversion to a Roth is probably appropriate if:
1 you have 10+ years to save until retirement
2. you have enough outside of the IRA to pay the taxes
3. your AGI is less than 100k
4. you expect to be in the same or higher tax bracket when you retire

On the flip side, it would probably be most beneficial to leave it in the traditional IRA if:
1. you have fewer than 10 years to save until retirement
2. you need to tap the retirement account to pay the taxes on a conversion
3. your AGI is more than 100k
4. you expect to be in a lower tax bracket when you retire

One more note, don't confuse the Roth IRA with the new Roth 401k. They are not the same thing. The Roth 401k is another interesting savings vehicle, but I will have to examine that at another time.