Individual Retirement Accounts

As part of the 1997 Taxpayer Relief Act, the Roth IRA was introduced to provide taxpayers with a unique means of saving for retirement and other goals. The principal difference between the Roth and the traditional IRAs is related to the taxation of contributions and distributions. While a deduction can be taken for contributions to a traditional IRA, there is no deduction for contributions to a Roth IRA. Instead, the earnings grow tax-exempt. This means that when money is withdrawn, there will be no taxes to pay. Therefore the key difference between Roth and traditional IRAs is that with the Roth, taxes are paid on contributions but not in retirement, and the opposite is true for the traditional IRA.

The Roth IRA may be preferable to a traditional IRA. The question one must answer to determine which one is best is at what rate the individual would like to pay taxes. While this may require making some assumptions about one's income sources in retirement, and assuming that tax laws will not change, it is still a reasonable approach to deciding which choice is best. If one expects his or her tax rate to increase in retirement, then a Roth IRA is preferable. This might be the situation for many young individuals, especially those just finishing college. If one expects it to decrease in retirement, then a traditional IRA is preferable. This may be the case for one who is making this choice later in life and is more established in his or her career.

As with a traditional IRA, individuals can place $2,000 into a Roth IRA each year ($4,000 for married couples). The increases provided by the 2001 TRA discussed for the contributions to a traditional IRA are also applicable to the Roth IRA. The rules regarding spousal Roth IRAs are the same as those for the traditional spousal IRA. The phaseout for allowable contributions for a Roth IRA is the same as that for those not participating in employer-sponsored retirement plans for the traditional IRA. Contributions to a Roth IRA can be made at any age, even beyond seventy and one-half.

Generally the rollover provisions of a Roth IRA are similar to those of a traditional IRA. In order to be eligible for a traditional-to-Roth rollover, certain conditions must be met. Failure to meet these guidelines subjects the rollover to a 6 percent federal tax for excess contributions as well as the 10 percent federal tax penalty; it also is included in ordinary income, and thus is subject to income taxes. Prior to 1999 the traditional-to-Roth rollover distribution could be taken over a four-year period, but this is not the case for new or current rollovers.

Distributions from a Roth IRA will be tax-free as long as they have been held in the IRA for five years or more and are withdrawn for appropriate reasons (the same as those for a traditional IRA). Otherwise, the early withdrawal penalty applies to the total amount withdrawn in that year. Unlike the traditional IRA, the rule requiring distributions to begin by age seventy and one-half does not apply to the Roth IRA. However, the rules regarding distributions after the owner's death are the same as those for the traditional IRA.