Tax-Deductible vs. Roth IRAs

Which is better, a traditional tax-deductible Individual Retirement Account or a Roth IRA? The traditional IRA gives you an immediate tax deduction, but all withdrawals are taxed as ordinary income. With a Roth, there's no upfront tax deduction, but all withdrawals in retirement can be tax-free.

Often, you won't have to pick a favorite because you only qualify for one. If you aren't covered by a retirement plan at work and you have earned income, you're always eligible to fund a tax-deductible IRA, no matter how much you make. But if you have a retirement plan at work, you might not qualify if your income is above the applicable threshold.

In 2012, if you're single and covered by your employer's retirement plan, your income needs to be $58,000 or less to fully fund a tax-deductible IRA. For married couples filing jointly, the cutoff is $92,000. Your ability to contribute phases out above these income limits.

With a Roth IRA, it doesn't matter whether you have a retirement plan at work. Instead, it all comes down to income. You can fully fund a Roth if you're single and your income is $110,000 or less, while the threshold for married couples filing jointly is $173,000.

But what if you qualify for both a tax-deductible and Roth IRA? You might decide based on your expected tax rate in retirement. If you think that rate will be lower than your current rate, you may prefer the traditional IRA. That way, you get a tax deduction today, while putting off taxes until retirement, when you hope to pay at a lower rate.

On the other hand, if you think you'll be paying taxes at the same or a higher rate, you might choose the Roth and what should be tax-free withdrawals in retirement. A Roth also offers a few additional advantages, including no required minimum distributions starting at age 70½ and the ability to withdraw your original contributions at any time without taxes or penalties.

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