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Should I open a traditional IRA or a Roth?

March 9, 2012: 10:15 AM ET

I anticipate that my take-home income this year will be approximately $105,000. I contribute to my company's 401(k) and expect to max out at the 2012 contribution limit of $17,000. I am 29, single, and have approximately $48,000 in my 401(k). To be ahead in saving for retirement, I was told to open either a traditional IRA or a Roth IRA. However, based on my current income, projected salary growth, and income phase-out for each, I am not sure which, if any, is better. Should I open a traditional IRA or a Roth? -- Name withheld

All things being equal, financial experts love Roth IRAs. You can't deduct your contribution, but then your money grows tax-free and can be withdrawn tax-free in retirement. You're not required to take distributions once you hit age 70 1/2, and if you really need cash in an emergency, you can withdraw your original contribution without penalty after the money's been in the account for five tax years.

What's more, a Roth provides tax diversification in retirement, when withdrawals from plans like 401(k)s are fully taxable. "Some people put so much into qualified retirement plans that they don't have anything outside of that," says Constance Stone, a financial planner in Chagrin Falls, Ohio. "By the time they get to retirement, they're locked in."

You're probably still within the income limits for a Roth IRA. In 2012, if your adjusted gross income is less than $110,000 (as a single filer), you can contribute up to $5,000 to a Roth. The amount you can contribute goes down when your AGI is between $110,000 and $125,000 and ends completely at an AGI of $125,000 or more. So for now, it looks like you're in the clear. (Contribution limits are higher for married couples filing jointly: in 2012, they can make a full or partial Roth contribution with an AGI below $183,000.)

You definitely make too much to consider a traditional IRA -- eligibility phases out at an AGI of $68,000 for single tax filers who have an employer-sponsored retirement plan.

Once you make too much for either account, you have the option of a nondeductible IRA, which is exactly what it sounds like—you can't deduct your contribution. You'll pay taxes on any earnings in the account when you withdraw the money, but you won't pay taxes on your contributions, since you put in post-tax money. (If you open one, don't forget to file IRS Form 8606.)

You also have the option of saving money in a taxable account, such as an investment account at a brokerage or fund company. If you go that route, Stone recommends tax-efficient mutual funds or exchange traded funds (ETFs) to keep your tax burden low.

--Kate Ashford

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