Why the Smart Money Chooses a Roth IRA

Smart investors are opting for Roth IRAs instead of traditional IRAs.

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Leave more money to heirs. You heirs will need to pay taxes on money you leave them in a traditional IRA. However, your beneficiaries may be able to receive tax-free distributions of money left to them in a Roth IRA.

Roth IRA conversions. In 2012, individuals earning less than $125,000 ($183,000 for couples) are eligible to make Roth IRA contributions. The maximum amount you are allowed to contribute to a traditional IRA, Roth IRA, or combination of the two is $5,000 in 2012, or $6,000 for those age 50 and older. The maximum possible Roth IRA contribution amount is lower for individuals earning more than $110,000 ($173,000 for couples). However, traditional 401(k) and IRA accounts can be converted to a Roth if you pay income tax on the amount rolled over. The IRS removed the $100,000 income limit for Roth IRA conversions in 2010, which means almost everyone now has the ability to open a Roth IRA by doing a rollover. "You can shift money that you have in a traditional IRA over to a Roth IRA, but you have to pay taxes on that shift," says Russell. But if you make the switch, "All the growth happens tax-free, and you get to take it out tax=free."

Tax diversification. Saving in both a traditional and Roth IRA adds tax diversification to your portfolio and allows you to be prepared for future tax-rate changes. "It allows us to essentially hedge against the risk that capital gains rates or income tax rates are going to go up in the future," says Finke. "We are taxed once on it when we put the money away and then we are allowed to defer additional taxation essentially forever."

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