Dear Carrie: I have a couple of 401(k) accounts that I rolled over into an IRA. My understanding is that any rollover is considered a "traditional" IRA. In addition, I'd like to add the max $5,000 a year into an IRA, but I feel that a Roth might be the best option. Would it be better to add to the IRA I've already got? Or add the $5K a year to a new Roth IRA? -- A Reader
Dear Reader: As tax advantaged retirement savings accounts, both a traditional IRA and a Roth IRA have their advantages. The first gives you tax benefits upfront, the second provides tax savings down the road. For young people just starting out who will most likely be in a higher tax bracket later on, a Roth IRA may be the best choice. For those in their peak earning years -- who can benefit more from the tax break now -- a traditional IRA likely makes more sense (and may be the only option).
However, for some folks, the possibility of having both types of IRAs working for them is the ideal. That's because having both a traditional and a Roth IRA can be a good way to help control your income tax bill when it comes time to make withdrawals. So, I'm glad you asked this question because it opens the door to looking at a Roth not only as a way to save for retirement but also as a part of your retirement tax strategy. But before you think about long-term tax planning, you first have to determine if you qualify for a Roth now.
DECIDING IF A ROTH IRA IS RIGHT FOR YOU
A Roth IRA is attractive for a number of reasons. Earnings grow tax-free; you don't pay income taxes on qualified withdrawals; and because contributions are made with after-tax money, you can withdraw them at any time without paying taxes or penalties. But no matter how good it sounds, a Roth doesn't fit the bill for everyone.
The first consideration is the income limitation. While income restrictions were lifted this year for Roth conversions, restrictions on new Roth IRAs remain. If you're single, your ability to contribute to a Roth IRA for tax year 2010 phases out between $105,000 and $120,000 of income. For married filing jointly, contributions need to be between $167,000 and $177,000.
You also want to consider your tax bracket now and in the future. If you expect to be in a higher tax bracket when you retire, a Roth makes sense because, while contributions aren't tax deductible, qualified withdrawals are tax-free. If you anticipate being in a lower tax bracket when you retire -- and it's more important to get the upfront tax deduction now rather than the tax-free withdrawal later -- contributing to your traditional IRA may be the better choice.
USING A ROTH AS PART OF YOUR RETIREMENT TAX STRATEGY