401(k) vs. Traditional IRA vs. Roth IRA

Below are most of the differences between a regular 401(k), Traditional IRA and Roth IRA. I haven’t yet had time to research the impact of the different accounts on estate planning (what happens when the account owner passes). Or how probate, having a Living Will or having a Living Trust will affect each. These are good questions to ask a professional.

IRS Publication 590 will give you the most information when it comes to comparing the rules and restrictions of the Traditional and Roth IRA. See www.irs.gov and look at publications and forms.

INCOME LIMITS

401(k) Generally none, but it could be complicated due to highly compensated employees rules.

Traditional IRA Based on your MAGI. You cam make a full contribution to a Traditional IRA if your income is less than $52k for Single, Head of Household (HoH), orMarried Filing Single (MFS) or $62k for Married Filing Jointly (MFJ) orQualifying Widdow (QW). You can make a partial contribution (see IRS publication for percentage breakdown) if your income is below $83k for S, HoH, MFS or $103k for MFJ or QW. You cannot contribute more than you made in the year.

Roth IRA Same rules as Traditional IRA except income limits are higher. Full contributions up to $99k for S, HoH, or MFS or $156k for MFJ or QW. You can make partial contributions up to $114k for S, HoH or MFS or $166k for MFJ or QW.

TAX IMPLICATIONS

401(k) Money is deposited as “tax deferred” which lowers your taxes now and any distributions are taxed in the year and tax rate the distribution takes place.

Traditional IRA You put in after tax money, but the money you put in is tax deductible reducing your taxable income for the year. Essentially the same end result as tax deferred above. Distributions are taxed in the year and tax rate the distribution takes place.

Roth IRA You put in after tax money so your taxable income is not lowered. When you take a distribution you do not owe any taxes. You do not even pay taxes on any of the earnings and gains you made. This is tax free growth and the key to why the Roth IRA is such a powerful tool.

CONTRIBUTION LIMITS

401(k) Up to $15.5k for under 50 and $20.5k for 50 and over in 2007. Combined employer/employee contributions must be the lesser of 100% of the employee’s salary or $45k

Traditional IRA Based on your MAGI. $4k for under 50 and $5k for 50 and over in 2007. Limits are for Traditional IRA and Roth IRA contributions combined.

Roth IRA Same as Traditional IRA.

QUALIFIED DISTRIBUTIONS

401(k) Distributions can be gin at age 59 ½ or if owner becomes disabled.

Traditional IRA Same as 401(k).

Roth IRA Same as 401(k) except the contributions must have been in the account for 5 years.

FORCED DISTRIBUTIONS

401(k) Owner must start withdrawing minimum funds at age 70 ½ unless still employed. Penalty is 50% of minimum distribution

Traditional IRA Same as 401(k).

Roth IRA No forced distribution.

CONTRIBUTION WITHDRAWALS

401(k) No. Loans may be available depending on the employer.

Traditional IRA No.

Roth IRA Yes. The owner can withdraw up to the total contributions at any time without penalty. Earnings cannot be withdrawn without penalty.

EARLY WITHDRAWLS

401(k) 10% penalty plus taxes including withdrawals for hardships

Traditional IRA 10$ penalty plus taxes but there are exceptions

Roth IRA Withdrawals of contributions carry no taxes or penalties. Withdrawals of earnings are subject to normal income taxes plus 10% penalty.

HOME DOWN PAYMENT

401(k) 10% penalty for purchase of primary residence or avoidance of foreclosure or eviction from primary residence

Traditional IRA Can withdraw up to $10k for a first time home purchase down payment (with stipulations)

Roth IRA Can withdraw up to $10k for a primary home down payment on a house owned by the IRA owner or direct linear ancestors or descendents. Must not have owned a home in the previous 24 months.

EDUCATION EXPENSES

401(k) 10% penalty on payment of secondary education expenses in the last 12 months for the employee, spouse, or dependents.

Traditional IRA Can withdraw for qualified education expenses of owner, children, and grandchildren.

Roth IRA Same as Traditional IRA

MEDICAL EXPENSES

401(k) 10% penalty on payment medical expenses not covered by insurance for employee, spouse or dependents.

Traditional IRA Can withdraw for qualified un-reimbursed medical expenses that are more than 7.5% of AGI or for medical insurance during a period of unemployment or when on disability.

Roth IRA Same as Traditional IRA