Roth IRA Alternative: The Traditional IRA
In part 1 of our discussion, I highlighted the benefits of the Roth IRA. While the advantages seem plentiful, like all decisions in life, you have to consider BOTH the pros and the cons.
As I mentioned last month, one benefit of the Roth is the nature in which money grows tax favorably over time. I called the concept “tax-deferred growth.” Another benefit is the ability to take money out tax-free during retirement. Because we do not know where tax rates are headed – most project upward – this feature could have an enormous benefit for you in the future.
Having said that, let’s make one thing clear, in that previous statement we are infact only speculating. There is no factual information or proof that rates will be higher. There is no way of knowing whether your income needs will be higher. Simply put, there is very little about the future that we know with 100% certainty.
As we come back to present day, I find this is the time of the year where people are more cognizant of where they put their money. Why is that? Do they suddenly have a new-found interest in personal finances, savings, and investing? Hardly. Rather, we just passed April 15 (i.e., tax filing deadline). Having seen how much money they’ve paid to the IRS, I see people looking for ways to reduce their taxable income more than ever.
This is where the Traditional IRA might be a useful tool for you. Here a 2 reasons why:
1. Tax-deferred growth. Like the Roth IRA, the money contributed to a traditional IRA also grows tax deferred. I discussed the benefits of this in great length last time, so here is a link in case you would like to review.
2. Tax-deductible contributions. Contributions made to a traditional IRA are federal tax deductible. In other words, if you make $100k a year, and you make a $5k IRA contribution, when you file your taxes you would be taxed as if you had made $95,000.
On the surface, this may seem like a small benefit, but if you consider that fact that our federal tax rates are progressive, meaning the as your income grows, the rate as which a portion of your income is taxed also grows. That $5k deduction can literally save your income from being subject to higher tax rates.
I don’t qualify for a Roth! Now what? Once you make more than $120k adjusted gross income (for tax-year 2010), you no longer have the ability to contribute to a Roth IRA. Fortunately for those who fall into this bucket, or those who anticipate having this issue in the future, the Traditional IRA has no such income limitation. However, there are some restrictions on the deductibility of your contributions. I won’t get into that at this time, but I would suggest contacting your financial and/or tax professional to learn more. I am also happy to answer questions — just leave a comment at the bottom.
Like all planning strategies, tools, and vehicles, there are always individual circumstances which make one vehicle appropriate over another, or one strategy appropriate for one individual, as opposed to anothers. In short, everything must be set it is appropriate context. Goals, present circumstances, and cash flow must always be considered before making any financial decision. Always consult your financial professional to determine if this vehicle is suitable for you.