Should I Invest in an IRA or Roth IRA?

By Larry Lane for InvestorZoo.com

The government designed IRAs (Individual Retirement Accounts) to give you the opportunity for your investments to grow tax free. This was done to help Americans self-fund their retirement and become less dependent on social security. As pensions have all but disappeared, it is imperative to take advantage of these great tax shelters and take your retirement into your own hands.

You can currently invest up to $5,000 per year in an IRA. If you are over 50, you can contribute up to $6,000. Your money grows tax free until you withdraw money. You can withdraw money at any time; however you will subject to a 10% penalty. In addition, the amount withdrawn will be taxed as regular income. For example, if you are in the 25% tax bracket and you withdraw $10,000 before 59 �, you will be subjected to a $1,000 penalty plus $2500 in taxes.

Exceptions:

1) You can tap your IRA penalty free if you withdraw equal amounts out of your IRA based on your life expectancy. Please see you accountant or contact the IRS for up to date life expectancy guidelines.

2) You can withdraw up to $10,000 for your IRA to help pay for a home for yourself, spouse, kids, grandchildren or parents.

3) You can also withdraw money penalty free to pay for higher education expenses. To qualify, the money must go toward tuition, fees and room and board expenses.

While you can take the money out penalty free, you will still have taxes to pay on the amount withdrawn. This amount will be counted as regular earned income.

Unless you are truly desperate, let you money grow tax free until retirement. In addition to being tax shelters, with few exceptions IRA are protected against legal actions. Should you be sued in civil court and found liable, your retirement account can’t be touched. When applying for financial aid for college, money invested within an IRA is not considered.

Start early!
There is no minimum age to participate in an IRA. If your child has earned income from working in a family business, they can be eligible to contribute to their IRA. Begin investing early and you’ll harness the power of compound interest. For example: You and your spouse start investing at age 35. If you each contribute $3,000 each and are able to generate 10% returns over the next 30 years, you will accumulate over $1,000,000. Remember, you’re only investing $6,000 per year or $180,000 over your lifetime.

Is it too late to start an IRA?
You can contribute to an IRA up until the age of 70 1/2. Once you pass the age of 70, the tax laws does not permit contributions.

In order to start an IRA, you need to have earned income. Income has to come from an employer, money earned in self employed or alimony. Unfortunately, you cannot use income derived from investments to fund your IRA. An IRA is funded with after tax money. You also may be eligible for a tax deduction! Please go to http://www.irs.gov/publications/p17/ch17.html for deductibility eligibility.
Withdrawing money from a traditional IRA

Upon reaching 59 1/2, you can withdraw as much money as you need from your IRA without fear of a 10% penalty. However, you will owe tax as ordinary income. Therefore, you should only withdraw money as you need it. This will allow your money to continue to grow tax free and you’ll be deferring your tax liability. You will need to start withdrawing money out of your IRA April 1 following the year you reach 7 . You will be forced to adhere to a minimum distribution schedule set by the IRS based on life expectancy.

Roth IRA                                                                                                           The Roth IRA makes an ideal tax shelter for a majority of investors. Although Roth IRA contributions are not tax deductible, IRA, the Roth IRA has many distinct advantages:

1) No mandatory withdraws
2) If you die and still have money in your Roth IRA account it gets transferred to your heirs tax free.
3) Your withdraws will not affect taxes applied to social security
4) Money withdrawn after age 59 � is tax free

Generally, you can contribute to a Roth IRA if you have taxable compensation and your modified adjusted gross income is less than:
•$176,000 for married filing jointly or qualifying widow(er),
•$120,000 for single, head of household, or married filing separately and you did not live with your spouse at any time during the year, or
•$10,000 for married filing separately and you lived with your spouse at any time during the year. 
Contributions can be made to your Roth IRA regardless of your age. 
You can contribute to a Roth IRA for your spouse, provided the contributions satisfy the spousal IRA limit, you file jointly, and your modified AGI is less than $176,000.
Time limitations: The deadline to contribute to an IRA is the tax deadline is April 15 for the previous year.

Withdrawing money from a Roth
Like an IRA, you face a 10% penalty should you withdraw money before 59. There are exceptions to this rule (see above).
Withdraw issues get a lot easier for those who have invested in a Roth IRA. Once you reach 59, and if you have had the account open for a minimum of 5 years, you can take as much from your account as you like. These withdraw come out tax and penalty free. There are also no minimum age restrictions when you have to start withdrawing money.

If you are eligible for a Roth IRA, try to contribute to the maximum amount. It may be difficult to invest $5000 and commit not to use that money until you’re 59 1/2. By starting out early, you will eventually reach a point where your investments will be adequately funded and contributions may not be necessary. Think about driving around a used car a few more years before buying a new one. Spending money now will have a big effect on your long term retirement planning.

Larry Lane is the editor for InvestorZoo.com, a social networking web site specializing in personal finance. Questions and comments can be sent to Larry.Lane@InvestorZoo.com

The article above is information of a general nature and the information provided may not apply to your personal situation. Please consult your financial planner or licensed professional for investment advice before making any financial transaction.