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I am feeling like I am missing the boat here. I am 27 yrs old and I have been contributing to a traditional IRA for sometime now (5yrs)at the max. After reading material on a roth I am torn as to which I should be contributing to and whether or not my wife should contribute to a roth (opening up an account soon) rather than traditional. As I understand it you potentially gain more from a roth because you are not taxed on your gains. Right? How does the penalty for early withdrawal differ between the two?
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Greetings, Dripfoolio, and welcome. You asked:

I am feeling like I am missing the boat here. I am 27 yrs old and I have been contributing to a traditional IRA for sometime now (5yrs)at the max. After reading material on a roth I am torn as to which I should be contributing to and whether or not my wife should contribute to a roth (opening up an account soon) rather than traditional. As I understand it you potentially gain more from a roth because you are not taxed on your gains. Right?

Yes, that is correct. If you expect your tax rate to drop in retirement (a myth for most who plan for their retirement), then a traditional IRA is best on a tax-adjusted basis. If you expect your income tax to stay the same, it's a wash. If you expect your tax rate to increase (a distinct possibility for dedicated investors), then a Roth is best.

How does the penalty for early withdrawal differ between the two?

Due to differing distribution rules, any withdrawal taken before age 59 1/2 from a traditional IRA will have a 10% penalty assessed in addition to ordinary income taxes. Depending on whether or not nondeductible contributions were made to the IRA, the penalty will apply to all or part of the withdrawal. In a Roth, contributions are considered the first money out, and they come back tax-free. Taxes and the penalty apply only when contributions are all taken and all that's left in the IRA are earnings. The earnings will be taxed and penalized when taken prior to age 59 1/2.

For details, see our IRA Area at http://www.fool.com/money/allaboutiras/allaboutiras.htm and IRS Publication 590 (Individual Retirement Arrangements) available for download at http://www.irs.ustreas.gov/forms_pubs/pubs.html.

Regards..Pixy
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Hi Dropfoolio,

Pixy pretty much summed it up, but there's one thing you should be aware of first (which I, unfortuantely, was not).

I'm sure you're aware that you have to fall into a certain income category to open a Roth, but be aware (you may already know this) that once you pass that income level, you cannot contribute at ALL to the Roth.

So, if you expect your tax rate to be higher in the future, but you never plan on making more than the income limits, then a Roth is good for you.
Otherwise, you'll never be able to contribute to the Roth, so the traditional would be better.

Of course, you can always have both.

-Chris
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