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Traditional vs. Roth IRAs

radroadkillradroadkill MDRegistered User regular
edited September 2008 in Help / Advice Forum
I am not savvy with these terms so I'm going for help here.

The past three years I've worked for a company that had an employee saving's plan in the form of a 401k. I ended my employment with the company in late July to move to California and get married; now that the move and marriage is done with and we've taken care of all our paperwork, my name change, and setting me up with Navy Federal Credit Union (NFCU) I've got my employee savings plan to transfer over from its current home in Wachovia to an IRA in NFCU.

The lady who set up my acocunt at NFCU gave me two forms: one for a Traditional IRA and one for a Roth IRA, depending on which I was going to do. (Or was it needed to do?) I just called a representative from Wachovia to update my information through them and to ask if it mattered which I did and didn't get an answer, other than to talk to NFCU. (Which isn't open yet.)

So what I want to know is: what's the difference between these two? Am I free to use whichever I'd like or is it dependent on my new institute?

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  • grungeboxgrungebox Registered User regular
    edited September 2008
    Roth IRA is usually better, though not always. Basically, the diff is that in a traditional IRA you can deduct your yearly contributions from your taxes, but you are taxed when you withdraw later in life. In a Roth IRA, you can't deduct contributions from your taxes, but you don't pay any tax when you withdraw later in life. In either IRA your money grows tax free (no capital gains tax).

    Unless you are in a very high tax bracket right now and make an obscene amount of money, I'd go with the Roth IRA.

    grungebox on
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  • RUNN1NGMANRUNN1NGMAN Registered User regular
    edited September 2008
    How much you and you spouse (if applicable) earn yearly is a big factor, because your allowed contributions get fazed out over a certain level. And it's not a "very high" tax bracket. I don't know what the phase out starts out at, but it's not particularly high for a married couple who both work.

  • DjeetDjeet Registered User regular
    edited September 2008
    Traditional IRA: When you fund a traditional IRA you can take an above-the-line deduction for any contributions you make to the IRA when you file your income taxes. You will need to pay taxes on the gains on these investments when you start taking distributions. (tax-deferred growth, because it was funded with non-taxed dollars)

    Roth IRA: When you fund a Roth IRA you may not deduct the contributions*. Though when you start taking distributions, you will not be liable for any taxes on gains in Roth IRA accounts. (tax-exempt growth, because it was funded with after-tax dollars).

    Your 401K likely worked like a traditional IRA (meaning it was probably funded with pre-tax dollars). If it was a Roth 401K then it worked like a Roth IRA (funded with money you already paid taxes on). I'm not sure if you can convert a traditional 401K to a Roth IRA (I would think there would be some fees involved, because you'd be converting from an account that was funded with pre-tax dollars to an account funded with after-tax dollars).

    Whether you want to fund a Roth IRA or Traditional IRA depends primarily upon what your marginal tax rate is now compared to what you think it will be when you take distributions. If you think your marginal tax rate is going to be higher at retirement time (likely if you're in your 20's-30's) then a Roth makes sense (better to pay 20-28% now and have it grow tax free in a Roth IRA, then skip paying taxes now and paying 30-40%+ when you take distributions from a Traditional IRA).

    For more detailed explanations look here.

    EDIT: Singles making more than 95K or couples making more than 150K cannot do Roth IRA (at least that's where the contribution limits start going down, not sure if they can participate or not).

    Djeet on
  • CauldCauld Registered User regular
    edited September 2008
    A regular IRA is tax deferred, meaning you pay taxes when you withdraw the money and not when you put it in. For a Roth IRA you pay taxes on your money, then put it into the IRA then don't pay taxes again. If your tax rate is the same when you put the money in as when you retire they're equivalent. If your tax rate is lower now than it will be when you retire a Roth is better. If your rate is higher now than it will be when you retire than a regular IRA is better.

    Roth IRAs also have some benefits, like you can take your money out penalty free if your account is more than 5 years old and you're using that money to buy your first house (I think this is still a rule).

    You should be able to use either one.

    Talk to woman who gave you the forms. She should be able to (or put you in contact with someone who can) help you decide which one you'd be better off with.

    Cauld on
  • RUNN1NGMANRUNN1NGMAN Registered User regular
    edited September 2008
    There also may be a tax penalty for rolling your 401(k) to a Roth, if the contributions to your 401(k) were tax deferred. Since Roth IRA contributions are after tax, you'll have to pay taxes on all those 401(k) contributions if you haven't paid income tax on them yet.

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