Contributing to Both IRA & Roth IRA Plans

Mark Kennan for Demand Media writes: Individual retirement accounts let you take control of your retirement savings -- you don't have to rely on an employer to set up a plan for you and you get to pick your own financial institution and investments. Assuming you're eligible, there's nothing stopping you from divvying up your retirement contributions between traditional and Roth IRA accounts.

QUALIFICATIONS

To contribute to either type of IRA, you must have compensation for the year -- income from working or taxable alimony you receive. However, just because you have compensation doesn't mean you're eligible to contribute to both types of IRAs. To add money to a traditional IRA, you also must be younger than 70 1/2. For Roth IRAs, your modified adjusted gross income must fall below the annual limits for your filing status. For example, in 2013, that means it can't exceed $127,000 if you're single or $188,000 if you're married filing jointly.

CONTRIBUTION LIMITS

The contribution limit for traditional and Roth IRAs are cumulative, which means that every dollar you contribute to one account reduces the amount you can contribute to the other. For example, in 2013, the maximum contribution is $5,500, so if you put in $3,000 for your traditional IRA, you can't deposit more than $2,500 in your Roth IRA.

EXCESS CONTRIBUTIONS

If your contributions to your traditional and Roth IRAs combined exceed your annual contribution limit, you're going to owe the IRS extra on your taxes because there's a 6 percent excess contributions penalty. For example, if your contribution limit is $5,500 and you put $4,000 in your Roth IRA and $3,000 in your traditional IRA, you're over by $1,500. Unless you correct it by taking out the excess plus any earnings on the excess before your tax filing deadline, you'll owe $90 in penalties. Plus, the penalty continues to apply every year until you correct the excess contribution.

WHICH IS BETTER?

Traditional IRAs and Roth IRAs offer opposite tax benefits. Traditional IRAs generally allow you to deduct your contributions, but tax you when you take withdrawals. Roth IRAs don't offer a deduction for contributions, but do allow you to take your money out tax-free in retirement. So, it's a good idea to allocate your contributions based on how your current tax rate compares to the rate you expect to pay when you're taking the money out. For example, if you're only in the 15 percent bracket now and you either think you're going to be making more in the future or tax rates are going up (or both), it makes more sense to put a bigger contribution in your Roth IRA.