Most people who have given thought to planning for retirement have at some point established a traditional IRA account. The ability to save money for later in life in a tax-advantaged fashion and reduce your tax bill today is understandably appealing. Traditional IRA’s allow you to delay the pain of taxes until retirement. However, a retirement planning tool that is used less frequently and also has important tax benefits is the Roth IRA. Available since 1998, there are several reasons to consider a Roth IRA versus a tradition IRA.

 Historically, higher income individuals haven’t been able to contribute to Roth IRA’s because of income limitations. However, beginning January 1, 2010, all taxpayers will have the ability to convert their traditional IRA balances to Roth IRA’s, regardless of their income. There are several advantages of a Roth IRA that you should understand if you’re considering either a conversion or future contributions to a Roth IRA.

 - Taxes: The biggest issues in a Roth IRA conversion are the tax treatment of the conversion and the tax consequences of withdrawing money during your retirement. When you convert to a Roth IRA, you will need to pay taxes on the amount converted since that money has not yet been taxed. The downside of a conversion is that it can create a substantial tax bill, but the IRS is allowing taxpayers who convert in 2010 to spread the tax burden out between 2010 and 2011.

 Money in a Roth IRA grows on a tax-deferred basis, just like it does in a traditional IRA. The big tax advantage of a Roth IRA comes when you start taking withdrawals from your account because those withdrawals are 100% tax free. This is a huge advantage over a traditional IRA, where withdrawals are 100% taxable as ordinary income. Tax rates in the US are at historic lows now and are likely to increase in future years, especially with the massive budget deficit that continues to grow. Tax-free income during retirement, when tax rates are likely to be higher, is a really great deal!

 - No RMD’s: Beginning at age 70.5 in a traditional IRA, the IRS forces account holders to start taking distributions and paying taxes on their invested funds, regardless of whether or not they need the income. A Roth IRA does not have an RMD rule, meaning that your invested dollars can continue to grow and compound if you don’t need the money for living expenses. You can also leave more money for your beneficiaries that can be distributed to them on a tax-free basis if you pass away before spending the money.

 - Liquidity: Traditional IRA’s have strict rules regarding withdrawals and harsh penalties for when those rules aren’t followed. With A Roth IRA, you have access to your contributions or converted dollars without tax penalties, and the earnings can be withdrawn without penalty five years after establishing your Roth IRA.

 With Social Security unlikely to last beyond the next 10 to 20 years without massive reform, it’s more important than ever to do everything you can to prepare for retirement on your own. A Roth IRA is one of the vehicles that can help ensure that your money lasts as long as you do, and you should at least be looking into whether or not a Roth IRA conversion is a good fit for you.

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Tags: IRA, Retirement Planning, Roth, Roth conversion

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