All individual retirement arrangements allow you to save money in a tax-sheltered account to use in the future. Being retired doesn't necessarily mean you're no longer eligible to take advantage of the tax breaks, such as deductions for traditional IRA contributions and tax-free qualified withdrawals from Roth IRAs. Which IRA is best for you depends on your circumstances and goals.
If you're completely retired, you might not be able to contribute to an IRA because all types of IRAs require that you have compensation. If your compensation is less than the standard contribution limit, you can't contribute more than your compensation. Compensation only includes your income earned from working, including self-employment income, plus any taxable alimony you receive. If you don't have any, you can't contribute. Couples share compensation if they file a joint return. If your spouse is still working and you file jointly, you can count compensation earned by your spouse -- after any of your spouse's IRA contributions -- as your own. So, if your spouse earns $50,000 and contributes $6,500, you're treated as having $43,500 in compensation -- more than enough to make a full contribution to your IRA.
Even if you've got compensation for the year, traditional IRAs also require you to be under 70 1/2 at the end of the year. In addition, even if you haven't reached that age yet, when you do, you're going to start having to take required minimum distributions from the account. So, the length of time you can take advantage of the tax-sheltered savings is limited. Roth IRAs don't limit who can contribute based on age, nor do they require required minimum distributions as long as you're alive.
If you're contributing with the hopes of lowering your tax bill, the traditional IRA is the best type for you -- assuming you're eligible. Traditional IRAs let you deduct your contributions on your taxes in the year you make them and don't tax the income until you take withdrawals. When you contribute to a Roth IRA, you won't get a tax break. Instead, your qualified withdrawals come out tax-free, including any of the profits that have accumulated on your contributions.
If you haven't already opened a Roth IRA, you'll have to wait at least five years before you can take qualified distributions from the account, in addition to being either 59 1/2 or permanently disabled. You can get your contributions out at any time, but any earnings you withdraw count as taxable income and -- barring an exception -- accrue a 10 percent early withdrawal penalty. Exceptions only avoid the early withdrawal penalty; these include being 59 1/2, higher education expenses or medical expenses when you're unemployed. With a traditional IRA, you avoid the penalty as long as you're 59 1/2 when you take the withdrawal, regardless of how long the account has been open.
Leaving IRAs to Heirs
If you're likely to have more left over in your IRA after you die, it's important to consider what's going to happen to that money after you pass. Both traditional and Roth IRAs count as part of your estate. If the estate tax is an issue, Roth IRAs lower your bill because you don't get a tax deduction for contributions. If you've had a Roth IRA open for five years before you die, all the distributions are tax-free for the beneficiary. If you're in a very high tax bracket, but aren't worried about the estate tax, you might save more if you make a deductible traditional IRA contribution because the deduction saves you more than it will cost your beneficiaries in income taxes if your heirs are in lower tax brackets.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."