Understanding Roth IRA

If you can fully fund either a traditional IRA or Roth IRA, then a Roth IRA probably makes the most sense. The below article gives good information for a Roth IRA.

Tips for Managing Your Roth IRA by Sue Stevens

Roth IRAs differ from traditional IRAs in that you put away aftertax money, you are not required to take Required Minimum Distributions, and when you take out the money in the future you won't owe any tax at all. Because you use aftertax money to make your contributions, you don't get a tax deduction like you would with a traditional IRA.

Eligibility to Make Contributions
The contribution maximum is the same for Roth IRAs as it is for traditional IRAs. For 2007, you can contribute $4,000--or $5,000 for investors over age 50. (You have until April 15 to make a 2007 contribution.) The contribution limit goes up for 2008--to $5,000 for those under 50 and $6,000 for those over 50. The income thresholds, however, are higher than they are for deductible contributions to a traditional IRA.
Singles may make at least a partial contribution to a Roth IRA if modified adjusted gross income is less than $114,000 (in 2008 that increases to $116,000). Married couples filing jointly may contribute as long as their modified AGI is below $166,000 (in 2008 that increases to $169,000). Married filing separately may only contribute if modified AGI is less than $10,000.
You can contribute past age 70 1/2 as long as you have earned income and are otherwise eligible. You do not have to take Required Minimum Distributions at age 70 1/2.
Contributions can be made in the year the income is earned or up to the filing deadline of your tax return, not including extensions (April 15 in most cases).

Tax Penalties on Roth IRAs
There are fewer potential penalties for Roth IRAs than there are with traditional IRAs. Because you are not required to take RMDs, you won't run into that nasty 50% penalty that you'll face if you don't take distributions from a traditional IRA on time.
You may, however, bump into the 10% early distribution penalty if you tap your Roth IRA before you're age 59 1/2. Here are the exceptions to that penalty:
You're disabled
You're an IRA beneficiary
You're a first-time homeowner and need to cover certain expenses
You have significant unreimbursed medical expenses
You're paying for medical premiums after losing a job
You have qualified higher-education expenses
IRS levy of a qualified plan
You're taking substantially equal periodic payments (same rules as under traditional IRA)

Claiming a Loss on Your Roth IRA
It is possible to take a deduction for a loss on your Roth IRA, but it may not make sense in every situation. The loss you can take revolves around your "basis," or the amount you've invested with aftertax money. You must withdraw the entire amount in your Roth to be eligible to claim a loss. Because the money you withdraw is a qualified distribution (a return of your own contributions) you would not owe a 10% penalty.
This type of loss is not like a capital loss on a taxable investment. With taxable capital losses you can deduct as much as $3,000 against ordinary income on your tax return and carry the rest of your loss forward indefinitely. With a Roth loss, you must use it in the year you generate it. So, if you sold your Roth in 2007 and realized a loss, you would claim it on your 2007 tax return. It goes on Schedule A and is subject to the 2% miscellaneous itemized-deduction threshold.
Think carefully before you liquidate your Roth IRA, however. For example, if your Roth is worth $20,000 and you pull it all out to recognize a loss, you'll only be able to put back $5,000 this year--the Roth contribution limit for 2008 ($6,000 for people over age 50). You would lose the advantage of having accumulated a greater balance in your account.
The same principle of taking a loss applies to nondeductible traditional IRA contributions, but not tax-deductible contributions. For more information, see IRS Publication 590.

Roth Distributions
You can always take out your contributions without paying income tax. After all, you paid the tax on that money before it was contributed to the Roth IRA.
For the earnings to be distributed tax-free (that is, qualified), you must hold for at least five years plus one of the following:
Attain age 59 1/2
Be a beneficiary of the IRA
Be disabled
Be eligible for a qualified first-time homebuyer withdrawal of as much as $10,000
There are ordering rules for taking nonqualified distributions out of a Roth IRA. To figure out how much tax you owe, you first subtract your regular contributions. If your distribution is more than your original contributions, then you look to any conversions you did, and finally to earnings on contributions.

Should You Convert Your Traditional IRA to a Roth IRA?
If you think income tax rates may go up in the future, you may want to consider taking part (or all) of your traditional IRA, paying tax now, and converting it to a Roth IRA.
To convert a traditional IRA to a Roth IRA, you pay the tax on the traditional IRA up front with money from a separate account. If you have to use money in your traditional IRA to pay the tax on the conversion, it will be considered an early withdrawal (assuming you are under age 59 1/2), and you will owe a 10% penalty on it.
Converting to a Roth doesn't have to be an all-or-nothing proposition. You can convert part of your traditional IRA. You should consider a conversion if you expect tax rates to go up, to avoid taking Required Minimum Distributions at age 70 1/2, or to be able to contribute longer.
There can be several advantages to converting your traditional IRA to a Roth, but what has stopped many people (until recently) is the fact that if your AGI is more than $100,000, you can't convert.
Begining in 2010, however, anyone will be able to convert a traditional IRA to a Roth, regardless of income level. To take advantage of that opportunity, more people are now making nondeductible traditional IRA contributions so that they can build up the amount they will be able to convert in the future (in this scenario, you would only pay tax on the earnings of the nondeductible contributions because the contributions are made with aftertax dollars).
Keep in mind there are always potential disadvantages of converting a traditional IRA to a Roth IRA--like the possibility of a totally new tax system that would change the rules. If we have a flat tax or a consumption tax in the future, it may turn out to be a mistake to pay more income tax now.

Roth 401(k) Accounts
In 2006, companies started offering Roth 401(k) options. A Roth 401(k) is a variation on a traditional 401(k) retirement plan with some of the characteristics of a Roth IRA. More and more firms are now offering this type of plan.
Just like the traditional 401(k) plan, Roth 401(k) contributions are limited to $15,500 in 2008 ($20,500 if over age 50). Your contributions can be split between the traditional and Roth plans.
You'll get an income-tax savings through traditional 401(k) contributions, but not with Roth 401(k) contributions. But unlike a Roth IRA, there are no income limitations on contributions to a Roth 401(k). So for those of you with higher incomes, this may be an alternative to making nondeductible traditional IRA contributions. A Roth 401(k) does require that you take required minimum distributions at age 70 1/2, but you can avoid that if you roll your Roth 401(k) over to a Roth IRA.

Best Type of IRA

An article I found on the internet on which type of IRA is best, Traditional or Roth IRA

Roth IRAs: Good for You or Not? by Andrea Coombes

Advisers debate whether Roths are the right move for many investors
If you've only got so much to put aside every year into a retirement account, you want to ensure you're stashing it in the best retirement-savings vehicle around. Does that mean a Roth IRA? A traditional IRA? Your standard 401(k) or, now, the Roth 401(k)?
Planners often say that, because Roth IRAs allow your money to grow tax-free -- the contributions you put in are after-tax but your investment returns are untaxed when you pull them out -- they trump traditional deductible IRAs, in which you enjoy a tax deduction now but pay taxes on your payouts later.
Similarly, advisers often say those who have a 401(k) at work should put as much into it as needed to get the full employer match, if there is one, and then stash the rest of their cash in a Roth. (Eligibility for Roth IRAs is restricted by income limits. Those income limits don't apply to the new Roth 401(k), but those plans are only available through employers, and not all companies offer them.)
One financial adviser challenges that conventional wisdom.
Roland Manarin, founder of Manarin Investment Counsel, in Omaha, Neb., says investors will watch their dollars grow faster in a tax-deferred account, such as a deductible IRA or a 401(k), because the tax-deferral allows savers to contribute more now than they can afford to contribute to an after-tax Roth -- and that greater savings rate compounded over years of investing equals a much bigger pot of money when it comes time to retire.
"To put $4,000 into a Roth, you have to effectively earn $6,000," because of taxes, Manarin said. "To put $4,000 into a regular [deductible] IRA, your take-home pay goes down by $3,000. What a huge difference," he said. "Let's turn it around: You put $4,000 in a Roth, that's the equivalent of putting $6,000 in a regular IRA. There's just no comparison."
Then, "you compound that difference over 20, 30 years. Now I'm facing retirement, I'm going to be in a lower tax bracket, I've got three times the money in my regular IRA versus the person in the Roth," Manarin said.
Plenty of other advisers disagree, some of them vehemently. The problem, they say, is that it's almost inevitable tax rates will jump higher in the years ahead.
Even with a bigger account balance in a tax-deferred account, "what if that compounded growth gets taxed at 50%, 60%, or 70%?" said Ed Slott, the Philadelphia-based host of and author of "Your Complete Retirement Planning Road Map."
"We have a multitude of financial crises -- health care, the death of defined-benefit pensions, 78 million aging baby boomers -- somebody's got to pay for this ...Taxes have to go up. We're probably in the lowest tax rates we'll ever see in our lifetime," Slott said.
"Having a Roth removes the uncertainty of what future tax rates might be," he said. Plus, he pointed out another benefit to Roth IRAs: "Once you hit age 70 1/2, with traditional IRAs, you have to take the money out and pay the tax," Slott said. "With Roths, there are no required distributions. That money can stay growing tax free for the rest of your life."
Certainly, traditional IRAs trump Roth IRAs in terms of total assets, but Roths are much newer, enacted into law in 1997, some 23 years after traditional IRAs, which were created in 1974 by the Employee Retirement Income Security Act.
About 30% of U.S. households owned a traditional IRA in 2006 versus about 13% who owned a Roth IRA, and traditional IRAs held a total of $3.7 trillion in assets, compared with $178 billion in Roth IRAs, according to the Investment Company Institute, a trade group of mutual-fund and other investment companies.
Uncertainty ahead
Income taxes could increase. Or, the tax code may change entirely. Some policymakers are calling for a consumption-based tax, for instance.
It's that tax-law uncertainty which prompts Mandarin and his colleagues to focus on tax benefits today, rather than in the future.
"That's another appeal to us of the traditional [deductible] IRA. You're getting the benefit today," said Aron Huddleston, a vice president of Manarin Investment Counsel.
"We would rather take what we can get today. There are proposals out there like the Fair Tax, the flat tax, the national sales tax, what if one of those takes over? There might not even be an income tax," Huddleston said. "Looking forward 30 years, who knows what the tax situation is going to look like?"
Others say that uncertainty means it's best to hedge your bets against a variety of outcomes. Planners call it "tax diversification," said Sheryl Garrett, a certified financial planner and founder of the Garrett Planning Network, in Shawnee Mission, Kan. "You're hedging: What if [tax rates] go up, what if they don't?"
Tax diversification entails contributing to your 401(k) plan at least up to the company match, and then owning a Roth on the side.
Another idea is to focus on a Roth when you're young, Huddleston said. Your 20s are likely to be your weakest earning years, and thus your lowest tax-bracket years. Then, once your income rises, and your tax rate too, leave the Roth alone and focus on contributing into your tax-deferred plan.
"When you're in your 30s, 40s, 50s, you're probably in some of your peak earning years, relative to the rest of your life," Huddleston said.
"Most likely you're going to be in a higher tax bracket. That means you'll be able to get more money working for you in a traditional IRA," he said. "At retirement, you won't be working, so the odds are your tax rate will be lower when you make the withdrawals."
Different outcomes
The answer to the question of "which investment vehicle" works best will vary dramatically depending on your own personal situation, as well as the tax-law situation when you retire, said Laurence Kotlikoff, an economist at Boston University.
"The results very much depend on your age and income levels" when you begin your retirement savings, he said.
Kotlikoff co-authored a research study in December titled "To Roth or Not to Roth, That Is the Question," answering that question by running a number of hypothetical savings situations through his retirement-planning software, ESPlanner.
In many of the hypothetical situations, a 401(k) (or a deductible IRA) trumped a Roth, although sometimes just slightly. In other cases, the Roth led to a better outcome. Often, the difference was only slight.
"A regular 401(k) beats a Roth for a majority of our stylized households, but both offer a significant improvement over fully taxed savings," Kotlikoff and his co-authors wrote in the paper.
"Of course, future changes to the tax code can increase or decrease the value of either type of account," the paper says. "We therefore recommend investing in a combination of both account types that is tailored to household circumstances and attitudes toward risk."
Still, to Manarin's mind, the benefit of Roths is overblown. "What drives me wild is when they talk people into cashing in their IRA, paying all those taxes and putting the money into a Roth. It just makes zero sense to do that."

What is the Best IRA, Traditional or Roth?

The question of which IRA is the best IRA for an individual investor, a Traditional or a Roth? My answer is Yes you need to get one and which one depends on a couple of things.

A Traditional IRA is different from a Roth IRA in several ways shown below:

• In general, an investor in a Traditional IRA gets an income tax deduction while a Roth IRA does not.
• In general, a Roth IRA grows tax free an no income tax is paid on any gain in the future while a Traditional IRA grows tax tree and income tax is paid on any gain in the future.

If you have sufficient resources so that you can fund the IRA limit with either a Traditional or Roth IRA the Roth wins every time. Because the growth is tax free and no income tax is paid on any gain this gives the best value for an investor.

However, if you live on a limited budget a Traditional IRA may be better than a Roth IRA. The reason is the tax savings in the current year and the tax rate when the money is needed in the future.

Example: A investor has the resources to fund a Roth IRA by $3,000 a year. If a Traditional IRA gives the investor a tax reduction of another $1,000 each year that can be invested then $4,000/year can be invested. Due to re-investing of the tax deduction 25% more money is invested with the Traditional IRA. Which is better $3,000/year Roth IRA or $4,000/year Traditional IRA invested on average 9% per year for 30 years.

In 30 years, the Traditional IRA has a value of$545,230 that is taxable income while the Roth IRA has a value of $408,923 that is income tax free. Which is better? It depends on the tax rate at the end of 30 years. If the tax rate is the same as when the original money was invested, 25% the after tax value of the Traditional IRA is $408,923, the exact same as the Roth IRA.

If the tax rate is less, which is a real possibility, the Traditional IRA is better. If the tax rate is 20% the after tax value of the Traditional IRA is $436,184. This is better than the Roth by about $25,000.

If the tax rate is higher, which is a nice problem to have, the Roth IRA is better. If the tax rate is 30% the after tax value of the Traditional IRA is $365,304. The Roth IRA is better by about $44,000.

Which is better a Traditional or Roth IRA? It depends on the availability of resources, if the tax savings that goes with the Traditional IRA is invested, and the income tax rate when money is removed from the Traditional IRA account.