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Old School Traditional IRA versus New School Roth

Money Magazine says that the generation gap has a new frontier: IRAs. The article, “Why Older Americans Should Get Hip to the Roth IRA,” says that the older you are, the more likely you are to favor a traditional IRA over a Roth IRA. However, older investors might want to look at what the youngsters are doing.

About a third of Roth IRA investors are younger than 40, compared to just 15% of traditional IRA investors, says research from the Investment Company Institute. At the same time, just 24% of Roth IRA investors are older than 60, compared to 39% of traditional IRA investors, according to IRA account data from 2007-2014.

These skewed results developed naturally—as Roth IRAs have income eligibility limits for contributions, and traditional IRAs don’t (but there are limits on deductibility). Roth IRAs have appealed to younger, typically lower-paid workers for some time. Traditional IRAs, which have been around longer, see retirees rolling assets from their 401(k) plans into a traditional IRA. It is the rollover money that is the largest share of IRA growth.

A Roth IRA is funded with after-tax dollars, and that money grows tax-free. Plus, qualified distributions after age 59½ are also tax-free. With a traditional IRA, the investment is funded with pre-tax dollars. Typically, you receive an immediate tax deduction, and the money grows tax-deferred; however, distributions after age 59½ are taxable as ordinary income.

You’re not eligible to contribute to a Roth as a couple if your household income is more than $194,000—for singles, it’s $132,000. Also, contributions will phase out at slightly lower income levels. Nonetheless, even high earners can start a Roth by converting assets from a traditional IRA because—beginning in 2010—there’s no income limit on who’s eligible to convert to a Roth.

Uncle Sam says that you’ll owe ordinary income tax on any amount you convert. It’s generally not recommended to convert if you have to use converted funds to pay the tax. It would be a good time to consider a conversion when your income is down and you can convert at a lower tax rate—or when your investments have lost money, which would reduce your tax bill.

The reason for converting is—even though it’s not a given that your tax rate will go down in retirement—by saving with a Roth, there are fewer worries. A Roth conversion is also a great estate planning tool.

Speak with a qualified estate planning attorney about how a Roth IRA can fit into your estate strategy.

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