Tax planning and compliance for investors
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Kaye A. Thomas
Updated January 19, 2008
When in doubt go with the Roth: it's usually the right decision.
There are plenty of details on choosing between a traditional account and a Roth account elsewhere in this guide. This page is for those of you who don't want to plow through lots of analysis — or who want a quick way to check whether you came to the right conclusion. These rules of thumb represent my judgment about when it generally makes sense to choose the Roth IRA. The reasoning behind these rules of thumb appears in other pages of this online guide and in our book, Go Roth!
One of the alternatives to a Roth IRA is a regular taxable account with a bank, mutual fund or stockbroker. Either way you get no deduction when money goes in. The Roth IRA provides earnings that are tax-deferred and possibly tax-free. But if you make a taxable withdrawal of earnings from the Roth IRA, you'll report ordinary income (not long-term capital gain), and you may pay a 10% early distribution penalty.
If you participate in a retirement plan maintained by your employer and your income is above certain levels, you may face a choice between saving in a Roth IRA or making a nondeductible contribution to a traditional IRA. In either case you get no deduction for your contribution, but the Roth IRA provides greater flexibility in withdrawing your contributions, and the possibility of withdrawing your earnings tax-free. This is an easy decision: the Roth IRA is better.
The choice between saving in a Roth IRA and a deductible contribution to a traditional IRA is more difficult. The traditional IRA gives you a deduction when you contribute, but the Roth IRA gives you a chance to have earnings that are entirely tax-free for decades to come. Here are the main ideas here:
If your employer provides a 401k or similar plan, you may face a choice between contributing to that plan or a Roth IRA. Don't forget you can do both!
Finally we come to the most complicated choice: whether to convert your traditional IRA to a Roth IRA.
Once again, these are merely rules of thumb. In most cases they give the right results, but your particular situation may call for a different answer.
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