Can you tell me the difference in an IRA and a ROTH IRA?

Question

Can you tell me the difference in an IRA and a ROTH IRA?

Answer 1

In a nutshell:

With a regular IRA you invest with pre tax dollars and are taxed when you begin disbursements during retirement.

With a Roth IRA, you invest with after tax dollars and are not taxed when you begin disbursements during retirement as long as certain rules are followed.

With both your money grows tax free while it remains in the account.

Of course, it is all more complicated than that.  You should consult with a financial adviser to determine what is best for you.  Many companies, inlcuding Wachovia Securites, will meet with you for free and help you invest if you open an IRA with them.

Answer 2

There are some good pointers here, however let me see if I can help fill in some of the blanks.

Individual Retirement Arrangement ("IRA"):

1. Contributions are considered pre-tax as long as your income is not not high.

"  * Married Filing Jointly or Qualified Widow and Modified Adjusted Gross Income is between $83,000 and $103,000 in 2007. If you are not covered by an employee-sponsored retirement plan but your spouse is, the limits for 2007 (married filing jointly) are $156,000 and $166,000.

    * Married Filing Separately (and you lived with your spouse at any time during the year) and modified AGI is between $0 and $10,000

    * Single, Head of Household or Married Filing Separately (and you did not live with your spouse) and modified AGI is between $52,000 and $62,000"

Main Advantages:

If meet the income standards above, you receive a tax partial deduction on contributions to the IRA. All gains grow tax differed until withdrawn.

Main Disadvantages:

100% of contributions and any gains are taxed at ordinary income levels at whatever tax rates are in the future when withdrawals begin, no earlier than 59 1/2. Any withdrawals taken out before 59 1/2 (except below) will have an additional 10% IRS tax penalty on the full amount. And the entire amount is subject to state and federal income tax.

Exception:

$10,000 may be taken out to buy a first home with no penalty. Certain health care, and high education expenses are also exempt from penalties.

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ROTH IRA

1. Contributions are not tax-deductible, and in order to have a ROTH your income can not exceed Federal income limits.

For 2008:

   " * Single filers: Up to $101,000 (to qualify for a full contribution); $101,000-$116,000 (to be eligible for a partial contribution)

    * Joint filers: Up to $159,000 (to qualify for a full contribution); $159,000-$169,000 (to be eligible for a partial contribution)."

Main Advantages:

All gains grow TAX FREE.

Requirement for tax free withdrawals:

1. Must open and hold the ROTH IRA for 5 full years (don't touch = "no withdrawals"). You can still buy and sell stocks, mutual funds, Bank CD's money market, bonds, etc, at any time.

2. After 5 years, you can withdraw up to 100% of the PRINCIPLE (the cash you put in the account) at anytime with NO penalty. Best to try and keep it in if all possible - it should be geared for retirement only.

3. The INTEREST or any GAINS MUST stay in the account until at least 59 1/2 or suffer IRS 10% tax penalty on the gains only,  plus pay ordinary income tax on the entire gain that was withdrawn.

Exception:

$10,000 may be taken out to buy a first home with no penalty. Certain health care, and high education expenses are also exempt from penalties.

Main Disadvantages:

No tax deductions on current tax return.

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Which is better?

In my view, the ROTH offers greater long term flexibility by allowing access to your principle after 5 years where the Traditional IRA does not.

Next, when you think 10, 20, 30+ years of growth and NOT having to pay ANY taxes on a ROTH at retirement (min age: 59 1/2), the NET growth potential of the ROTH is effectively greater because the Traditional IRA will be 100% subject to income tax in the future at whatever tax rates Congress decides.

Example:

Value of IRA in 20 years: $100,000

Value of ROTH IRA in 20 years: $100,000

Federal Tax bracket in 20 years: 20% (hypothetical)

If take out all money at once: (normally some funds taken out each year not before 59 1/2 and not later than age 70 1/2 - minimum withdraws required by 70 1/2 - determined by a life expectancy formula - "actuary table." - don't need to know all this now, because the formula will change in the future.)

Federal Tax on IRA: $20,000 (20% tax bracket)

Federal Tax on ROTH: $0.00 (any tax bracket)

State Tax on IRA: (depends on your state)

State Tax on ROTH: 0%

Best:

Max out ROTH IRA each year. Even if you quality for the little tax deduction on the Traditional IRA with your current taxes, it will cost you more money in terms of paying more taxes in the future when the money comes out. ROTH IRA avoids the government from taking your money again in the future.

Final suggest:

Try and find a no fee IRA or Roth IRA account (Fidelity.com has one). Annual fees can reduce your overall returns in your account. If you have a retirement account with a fee, always pay the fee by writing a check each year instead of debiting the account for the fee.

Answer 3

They are both retirement accounts, where you make deposits and cannot touch them until you are in the your 60's (generally).  As an incentive to make deposits into the account for retirement, the government ususally allows you to reduce your income levels by the amount that you deposit into the account.  The biggest difference between the two is however, how the earnings in the account are treated at withdrawl.  The earnings in an IRA are taxed at the income level you are in when you retire (presumbly much lower than where you are not, since you will probably not be working.  The roth allows you to withdraw without paying any taxes.  There are rules around who can open a roth (if you make too much money now, you cannot open one), but if you qualify, you should definately go the Roth route in my oppinion.  tba

Answer 4

With a ROTH, after-tax dollars are used to make contributions.  The earnings will be tax free when you retire so no taxes will be due on any amount when withdrawals are made.  This option is best for young people with many years to comound their earnings.

A Traditional IRA uses pre-tax dollars to make contributions (either pre-tax, or taxes are refunded when you file your 1040 if after-tax dollars are used to contribute).  Taxes will be due on the entire amount withdrawn when it is distributed at retirement.  This option is best suited for those in their peak earning years (tyically 45+ years old) to lessen the tax burden for the given year.

I use a combination of the two, and contribute to both traditionan & ROTH plans for my retirement egg.  I'm 49.

Answer 5

www.ira.com

Answer 6

The above answers are very good.  Here is a wikipedia article comparing and contrasting the various retirement plans.

http://en.wikipedia.org/wiki/401(k)_IRA_...

Answer 7

A "regular" IRA - the funds going in are tax deferred.  You don't pay tax now, you pay when you take the money out.  You're also not allowed to take the money out before retirement age without paying a penalty.

A ROTH IRA - funds going in are monies that you have already paid tax on.  So taking the money out is more like just taking money out of your savings account.