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Featured in Columbus Dispatch (Oct 2009)
Roth vs. Traditional IRAs: You Need To Decide In 2010
By Clint Edgington, CFA
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Generally, contributions to traditional IRAs
are tax deductible. However, once you withdraw from a traditional IRA, it is taken as
taxable income. Roth IRA contributions, on the other hand, are not deductible. In other words,
when you contribute to a Roth, you pay taxes on that money immediately. The benefit, however, is that
money can grow indefinitely and when withdrawn, you won't pay taxes.
Roth IRAs are more beneficial as:
-
Your future tax rate increases
- Your length of time until you withdraw increases
Regular IRAs are more beneficial as:
-
Your current tax rate decreases
- Your expectation of "game changing" events is lower.
In addition, Roth IRAs do not have the
required minimum distributions that Traditional IRAs do and enjoy more liberal withdrawal
rules.
Why 2010?
Conversions from Traditional IRAs to Roth IRAs have been limited if your modified adjusted gross income
has been above $100,000 for couples filing jointly. In 2010 only, this
restriction will be lifted. In addition, taxes due on the
amounts converted can be spread over 2011 and 2012- effectively
reducing your tax rate. While limitations on conversions are
lifted for 2010, the limited on contributions to IRAs has not
been waived.
Rules of Thumb
If you believe your tax rates will drop during the
withdrawal period, it likely does not make sense.
If you believe your tax rate will increase, it likely does make
sense.
If you do not have cash to comfortably pay the taxes due, it likely
does not make sense.
If you do not have a long time horizon (5 to 10 years) for the
tax-free compounding to occur, it likely does not make sense.
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