I am often asked whether it is better to contribute to a traditional, deductible IRA or to a Roth IRA. As with most personal finance questions, my answer is typically “it depends.” In this entry, I will provide some guidelines to help you decide which is best for you.

When I use the term “IRA,” I am only addressing deductible IRAs. In a future entry I will discuss why I believe that it is seldom wise to fund a non-deductible IRA.

Let’s first look at the rules:

With a traditional IRA, you must be under 70½ years old plus you and/or your spouse must have earned income. In 2007, your maximum contribution is the lesser of $4,000 ($5,000 if you are over age 50) or the total amount that you and/or your spouse earned. If you are covered by a retirement plan, you can only deduct the full amount contributed to your IRA if your Modified Adjusted Gross Income (MAGI) is no more than $52,000 as a single tax payer or $83,000 as a joint filer.

With a Roth IRA, your Adjusted Gross Income (AGI) must be less than $99,000 as a single filer or $156,000 as a joint tax filer plus you and/or your spouse must have earned income. In 2007, your maximum contribution is the lesser of $4,000 ($5,000 if you are over age 50) or the total amount that you and/or your spouse earned. If you make any deductible IRA contributions, the amount that you can contribute to a Roth IRA is further reduced by the amount that you contributed to the deductible IRA.

Based on these rules, the decision on which IRA to use is sometimes obvious:

1. If you are a single filer with an AGI over $99,000 or a joint filer with an AGI over $156,000 and you are not covered by a retirement plan, you can only fund an IRA.
2. If you are covered by a company retirement plan and your MAGI is over $83,000 but less than $156,000 as a joint filer or $56,000 but less than $99,000 as a single filer, you cannot receive full IRA deductibility, but you are able to fully fund your Roth IRA.
3. If you are over 70 ½ and have earned income, you can only fund a Roth IRA.
4. If you are saving to buy your first home, up to $10,000 of growth and income from a Roth IRA, plus all of the contributions may withdrawn, tax and penalty free.

Now let’s look at the more subtle differences between the IRA plans:

1. If you are under 40, the tax free growth combined with the tax free withdrawal of the funds (when you are over 59½) often make the Roth IRA a better, after-tax investment strategy.
2. If you may need some of the funds before you turn 59½, with a Roth IRA you can typically withdraw all of your contributions and pay no taxes or penalty on the withdrawal.
3. If you are over 40 and wish to pass some of your estate to your children, a Roth IRA is an excellent way to pass funds to younger generations.

When none of the above apply, the decision of funding a Roth IRA or a traditional, deductible IRA must be made by analyzing your current tax bracket, what you believe will be your future (retirement years) tax bracket and whether you expect to consume the retirement funds or pass them to future generations. This is never easy and often comes down to whether you want the tax reduction now or you can wait to get it later.