How to Determine Which IRA You Should Contribute To
by Shane Flait (2011)

As you approach retirement, you may still be contributing to an IRA plan. Both your income and whether or not you (or your spouse) have a qualified plan associated with work will determine which of the three IRA types - the traditional (deductible) IRA, the non-deductible IRA, and the Roth IRA - you should contribute to. However, when circumstances occur that give you a choice of contributing to two or more IRAs, here’s how to decide what to do.

Aside from whatever qualified plan – including none - you have at work, the total amount you can contribute toward your ‘at home’ IRA plan in 2011 is $5,000. If you’ve reached 50 years of age, you can contribute and extra $1,000. That means that if you’re over 50 and contributed $6000 to your traditional IRA, you can make no more contributions to either your non-deductible or Roth IRA – or vice versa – if you have them, too – because that’s the limit you can contribute to any or all of your IRA plans.  

Having an income higher than $56,000 (2011) if you’re single or $90,000 if you’re married will limit or prevent a deductible contribution to your traditional IRA; but that limitation only occurs if you have an ‘at work’ qualified plan. Contributions to Roth IRAs are always nondeductible but you can only contribute to them – if you have another plan at work - if your adjusted gross income is less than $122,000 (filing single) or $179,000 (filing married jointly).

Proceeds from traditional (deductible) IRAs will be fully taxed as ordinary income at ordinary income tax rates. This presumes that all contributions were fully tax deductible so the tax basis in the account is zero. Non-deductible contributions should go into a non-deductible IRA or a Roth IRA.

Proceeds from a non-deductible IRA will be taxed at ordinary income rates but only to the extent of its IRA earnings above and beyond your non-deductible contributions. The total of your non-deductible contributions is your tax basis in that non-deductible IRA accounts.

Proceeds from your Roth IRA are tax free since your contributions were non-deductible and your contributions’ earnings grow tax free – not tax-deferred as in the other two IRA types.

Additionally, the Roth IRA has no minimum required distributions, ever! This is important if you wish keep this account as a legacy and not deplete it while you’re living. And you can contribute only to a Roth IRA beyond an age of 70½ years – not to the traditional or nondeductible IRA accounts. Of course all contributions must always come from earned income during that year of contributions. So, do so if you’re creating a legacy.

 

Tax free and tax-deferred growths are somewhat equivalent since that growth is not diminished yearly by taxation. Now we present the rationale for when two or more IRA options are available to us:

Traditional vs non-deductible IRA

Contributing to a traditional IRA is more advantageous than a non-deductible IRA since you get a tax break at the time of contribution in the former but not in the latter. This allows you to shelter some of your yearly taxable (and earned) income and makes it easier to contribute more to the traditional IRA.  

Nondeductible vs Roth IRA

The Roth IRA is clearly more advantageous than the non-deductible IRA since contributions are treated equally as nondeductible, but the Roth’s earnings are never taxed – which is an important tax break at distribution.

Traditional vs Roth IRA

The Traditional IRA has an advantage over the Roth only if you plan to deplete your IRA during your retirement and your contributions were deducted at a much higher tax rate than the tax rate that applies when you take your distributions. Otherwise, go with the Roth IRA.

 

Shane Flait is a writer and educator. See more at www.EasyRetirementKnowHow.com