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Tax treatment of IRAs, part 1: traditional v. Roth

The proper use of retirement accounts is an important part of tax planning for many people.

In part, this is because there are some very specific rules that apply to the tax treatment of individual retirement accounts (IRAs). In order to use IRAs effectively to benefit from tax-deferred investments, it is necessary to know the basics about how those rules work.

In this two-part post, then, will take note of some of the issues taxpayers can face regarding IRAs and how they relate to individual income taxes.

Let's start by clarifying what the difference is between a traditional IRA and a Roth IRA.

One difference between the two types concerns when someone can contribute.

Under a traditional IRA, it is not possible to make contributions after the age of 70 ½. This is the case even if you (or your spouse when filing jointly) had taxable compensation at or after that age.

With a Roth IRA, by contrast, it is possible to make contributions from taxable compensation at or after age 70 ½ under certain circumstances. There are, however, certain income limits that apply.

There is also a difference between traditional IRAs and Roth IRAs on the deductibility of contributions. For taxpayers who qualify, traditional IRA contributions are deductible. But this is not the case with a Roth IRA.

In part two of this post, we will discuss other IRA issues, such as the taxability of withdrawals and the deductibility of contributions.

For now, however, let us merely note that with both traditional IRAs and Roth IRAs, withdrawals can be made at any time.

Source: IRS.gov, "Traditional and Roth IRAs," Accessed March 31, 2014

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