Roth Vs. Traditional Vs. Rollover IRA
An Individual Retirement Arrangement, or account (IRA), is a personal savings account that offers tax advantages when setting money aside for retirement. There are different types of IRAs, but the traditional and Roth IRA are most common for the average investor.
Traditional IRA
A traditional IRA is different from a Roth IRA or a SIMPLE IRA. Any individual under the age of 70#189; who earned taxable income during the year can set up and contribute to a traditional IRA. The maximum contribution to a traditional IRA for 2009 is the smaller of $5,000 or your taxable compensation for the year. For married taxpayers filing a joint return, the limit is $10,000 ($5,000 for each account). For taxpayers age 50 or older before Dec. 31 of the current tax year, the yearly contribution limit increases to $6,000 for an individual ($11,000 for married filing a joint return if one is 50 or older, and $12,000 if both are). You can make contributions to your traditional IRA for tax year 2009 up until April 15, 2010.
Tax Advantages of a Traditional IRA
One benefit of investing in a traditional IRA is that your contributions may be deductible. Depending on your income, you may be able to deduct up to the total amount of your contributions (as described in Section 1). This deduction reduces the amount of your income that is subject to income tax. However, when you eventually withdraw money from a traditional IRA you will owe tax on those distributions.
Roth IRA
A Roth IRA is subject to many of the same rules as a traditional IRA, with some subtle differences. For example, you can contribute to a Roth IRA regardless of your age, but the contributions are not tax deductible. The contribution amounts and limits of the Roth IRA are similar to that of the traditional IRA.
Tax Advantages of a Roth IRA
Qualified distributions from a Roth IRA are not taxable. A qualified distribution is one made at least five years after you set up your account, and is made when you are at least 59#189; years old; because you are disabled; or as part of your estate after your death.
Rollovers
A rollover is a tax-free distribution from one retirement account to another. The contribution into the second retirement account is called a rollover contribution. Rollovers can be made from a 401(k) plan, a 403(b) plan, a 457 plan or some other annuity plan, into both traditional and Roth IRAs. A rollover into a Roth IRA would be subject to the same rules related to converting a traditional IRA to a Roth IRA, meaning that you would have to pay taxes on the funds. A rollover must be made within 60 days of receiving the distribution from the first retirement plan.
Summary
Contributions to a traditional IRA may be fully tax deductible in the year contributed, but distributions are in most cases fully taxable. Contributions to a Roth IRA are not tax deductible, but the investments essentially grow tax free, as qualified distributions are not taxed. A rollover is a tax-free distribution from one retirement account to another. Rollovers can be made into both traditional and Roth IRAs.
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