Dale Suezaki and Taylor Easley | financial advisers Tax deductions now or tax-free withdrawals later? Roth vs traditional IRAs ADVERTISING We all like to think that we make rational and wise decisions when managing our money. But most of us
Dale Suezaki and Taylor Easley | financial advisers
Tax deductions now or tax-free withdrawals later? Roth vs traditional IRAs
We all like to think that we make rational and wise decisions when managing our money. But most of us are influenced far more by our emotions than our brains. Why do smart people make irrational investment decisions so commonly and so easily? The fascinating study of behavioral economics and decision science fills many books, but let’s look at a few of the ways in which investors’ minds play tricks on them.
Traditional and Roth IRAs are tax-deferred ways to invest for your retirement. A detailed look at each can help you decide which may be better suited for you. There are certain rules that apply to both.
— To contribute, you or your spouse must have received taxable compensation for the year.
— The annual contribution limit for 2006 is $4,000. If you own more than one IRA, this limit applies to the combined contribution total for your traditional and Roth IRAs.
— Those 50 and older can make an additional $1,000 catch-up contribution for 2006.
— If you withdraw money before age 59 1/2, a 10-percent-tax penalty may apply to the taxable portion of the distribution.
Traditional IRA specifics
The advantage of traditional IRAs is the tax deductibility of the contributions. Although you may contribute up to the annual maximum no matter how high your income, you may not be able to deduct the entire amount of your contribution. If you or your spouse participates in an employer-sponsored plan, your deduction may be limited because of deductibility phase-out rules applicable to traditional IRAs. Contributions must stop when you reach age 70 1/2, when annual required distributions begin. Withdrawals (except for nondeductible contributions) are taxable as ordinary income.
Roth IRAs
The big attraction of Roth IRAs is that withdrawals are tax free after you reach age 59 1/2 and a five-year holding period has been satisfied. Distributions are never required and you can contribute past age 70 1/2 if you have taxable compensation. Withdrawal of earnings may be subject to taxation; whereas contributions, which are not deductible, can be withdrawn at any time without taxation. Eligibility to contribute is subject to the Roth IRA income phase-out guidelines.
Converting to a Roth
You may convert all or part of a traditional IRA to a Roth IRA if your adjusted gross income for the year does not exceed $100,000* and you are not married and filing separately. The amount converted is taxable as ordinary income for the year unless it is from nondeductible contributions.
* Beginning in 2010, the Tax Income Prevention and Reconciliation Act of 2005 eliminates the $100,000 annual income limitation that currently prevents some taxpayers from converting traditional IRAs (or SIMPLE IRAs) to Roth IRAs. As a result, any taxpayer, regardless of income, will be eligible to convert SIMPLE or traditional IRA assets to a Roth IRA.
Articles are published for general information purposes and are not an offer or a solicitation to sell or buy any securities or commodities. Any particular investment should be analyzed based on its terms and risks as they relate to your specific circumstances and objectives. Morgan Stanley does not render advice on tax or tax-accounting matters.
Dale Suezaki and Taylor Easley are financial advisers at Morgan Stanley, 329-7979.
