Talkin Cash With Walt: LOOKING FOR A TAX BREAK: THE ROTH IRA, A BETTER DEAL

If you're confused about which type of Individual Retirement Account to choose, consider the Roth IRA. Compared to an employer-sponsored retirement account, such as a 401(k) or 403(b) or a traditional IRA, the Roth is by far more flexible and in most cases will leave you with more money at retirement.

The exception to this theory is if your employer matches your contributions, then it's probably best to take advantage of that free money. But only contribute up to the point that contributions are matched; after that, send your retirement money to a Roth. On the other hand, if you have to stay with a company for a number of years before those matching contributions will be considered yours (vesting), then go straight to the Roth.

Why is the Roth a better deal?
The maximum that can be deposited in a Roth is $3,000 ($3,500 for workers age 50 and older). Unfortunately, not everyone is eligible. Once your adjusted gross income (AGI) reaches $95,000 if you're single or $150,000 if you're married, the amount you can contribute to a Roth begins to decrease, reaching zero for those with an AGI of $110,000 (single) or $160,000 (married). So, if you're not eligible for a Roth, stick with your 401(k) and/or traditional IRA.

The major difference between a Roth and the other retirement accounts is the timing of your tax break. Contributions are deductible for traditional IRAs. The 401(k) s reduces your taxable income in the year you make the contribution. These are Taxed Deferred Accounts. They are "tax-deferred" because you don't pay taxes on the interest, the dividends or the capital gains until you take the money out. Then the money is considered ordinary income and will be taxed at the same rate as income earned from a job.

With a Roth, contributions do not reduce taxable income, so there's no deduction. However, the Roth is a Tax Free Account because no taxes are paid on the interest, the dividends or the capital gains, ever. This is the better deal. It is better to have the heavier tax burden while you are working and earning a paycheck than when you are retire. Finally, the more taxable income you receive in retirement, the more likely your Social Security benefits will also be taxed. Income from a Roth IRA, however, does not affect the calculation.

As mentioned earlier, employer-sponsored retirement accounts and traditional IRAs are tax-deferred; you'll have to pay taxes on the money at some point. And Uncle Sam doesn't want to wait forever, so he came up with something called Minimum Required Distributions (MRDs). According to the rules, you must begin taking money out of your 401(k) or traditional IRA by April 1 of the year following the year in which you reach age 70-1/2 whether you need the money or not. (If you're still working, you can delay MRDs in your 401(k) until after you retire.)

Also, a Roth IRA is good for the beneficiaries of your estate. Just as you would receive the proceeds of a Roth tax-free, so will your heirs. However, beneficiaries have to pay income taxes on the money inherited from 401(k) s and traditional IRAs.

Withdrawals from an employer-sponsored retirement plan or a traditional IRA before the age of 59-1/2 can lead to taxes and penalties (except under special circumstances). This is not necessarily true for a Roth.

Contributions to a Roth can be withdrawn at any time without penalties and tax-free. For example, let's say you contribute $3,000 to a Roth this year, and in three years, it grows to $4,000. You can withdraw your three-grand contribution at any time, no questions asked. Not so with 401k or traditional IRA.

So, if you plan to retire early, the Roth is a great place for your money because you can start withdrawing the money before age 59-1/2 without a hassle. Some experts suggest that this also makes the Roth a good account for college savings, emergency savings and other goals. Believe it or not, those arguments have merit, but it's a complicated discussion--a topic for a future article. n