Wednesday, December 20, 2006

Comparing Traditional IRA to Roth IRA

In my last blog, I talked about the difference between Traditional IRA and a Roth IRA. Let's compare them in numbers. This is a hypothetical illustration and actual results may vary.

Let's say you invested $6000/year for 30 years at a 10% rate of return. Your annual income tax is 27%.

If you invested this money through a Traditional IRA, in 30 years you will have $685,500.
If you invested this money through a Roth IRA, in 30 years you will have $1,192,500.
That's a difference of $507,000!!

Why? In Traditional IRAs, your withdrawals maybe fully or partially taxable, depending on whether you treated them as tax-deductible when you do your taxes. In Roth IRAs, any withdrawals you make after age 59 1/2 are tax-free because none of your contributions are tax-deductible.

Here are some more differences between Traditional IRA and Roth IRA.
1) There is maximum contribution limit you can make in any given year. If you are age 50 or above, you can contribute an additional $1000 to your IRA.
2) 10% penalty on any NON-QUALIFYING withdrawals before age 59 1/2.
3) Rule 70 1/2 only applies to Traditional IRAs.
4) Initial 5 year holding period only applies to your first Roth IRA and all conversions.
5) In Traditional IRAs, your contributions are tax-deductible up to a certain limit.
6) In Roth IRAs, your contributions are not tax-deductible.
7) In Traditional IRAs, your withdrawals maybe fully or partially taxable.
8) In Roth IRAs, your withdrawals may be tax free after age 59 1/2.
9) In all IRAs, your investments grow tax-deferred
10) Many, if not all, financial companies charge an annual custodial fee on the IRA account. In most cases, this fee will be automatically be deducted from the IRA, unless you choose to pay it by writing a check