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The Ever Unpopular Traditional IRAs

Posted By Jim On 09/24/2007 @ 12:21 pm In Retirement | 10 Comments

Ever notice that tons of personal finance sites talk about Roth IRAs all the time but rarely talk about Traditional IRAs? I think part of the reason is that the Roth IRA is newer so there’s far less literature on it and because it’s sexier – forty years of tax free appreciation and then no tax on disbursement? That’s pretty hot. The downside is that some people can’t contribute to the Roth so they’re stuck with the Traditional route, something that isn’t discussed as much.

About Traditional IRAs

The Traditional IRA is much like the Roth IRA except contributions are tax deductible unless your employer offers a retirement plan. This means you get tax savings immediately since your income will be reduced by the amount of your contribution. It’s very much like a 401k from a tax perspective, which explains why the deductibility rules are structured the way they are. If your employer offers a 401k, Keogh, SEP-IRA, etc; then the deduction is limited. The rules are a little complicated so I direct you to a past article I wrote about IRS income phaseouts [3] (specifically IRA contributions) with respect to contribution limits and deductibility.

From there, the Traditional IRA grows tax free much like a Roth IRA. However, whenever you start taking disbursements, those earnings are then taxed at your marginal tax rate. You are also required to take minimum disbursements once you hit the age of 70½, which is something you are not required to do with a Roth IRA. If you don’t take the required minimum distributions [4] then you will be penalized (you will always want to take these distributions).

Finally one last distinction worth noting with respect to Traditional and Roth IRAs; if you make an early withdrawal on your Traditional IRA, you will have to pay taxes plus a 10% penalty. With a Roth, you can withdraw them contributions at anytime (since you’ve already paid taxes on it).

So, why a Traditional IRA and not a Roth? There are two reasons:

  • Income restrictions. If you have too much income, you will be prohibited from contributing to a Roth IRA, this is the main reason why folks choose Traditional over Roth (or rather they settle, because they never had the choice).
  • Tax law concerns. The government can always decide to tax Roth IRA disbursements, which means you’d be doubly taxed. This is less of a concern but still one that bears mentioning since it could always happen.

Traditional IRA Conversion

Another considering for those thinking about Traditional IRAs is that if you have a modified adjusted gross income in excess of $100,000, you currently cannot convert your Traditional IRA to a Roth IRA. However, in 2010 and 2011, that prohibition will be lifted so anyone can do the conversion. When you convert all or part of your Traditional IRA, you pay taxes immediately on the funds converted if you haven’t done so already.


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[3] IRS income phaseouts: http://www.bargaineering.com/articles/comprehensive-guide-to-irs-income-phase-outs-rules.html#iras

[4] required minimum distributions: http://www.myretirementblog.com/ira-required-minimum-withdrawals.html

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