There are many Individual Retirement Arrangement (IRA) types, but one common question most people ask is how to choose between a Roth IRA and a Traditional IRAs. These are the two most common types of IRAs.

If you don’t have access to a retirement account through work or are looking to put away more in retirement savings, Roth and Traditional IRAs are great options.

What is an Individual Retirement Arrangement (IRA)?

An IRA is a saving plan that lets you set aside money for retirement now while receiving tax benefits. Unlike other kinds of retirement accounts, you can open most IRAs on your own — you don’t have to go through an employer.

Why should I open a Roth or Traditional IRA?

A Roth or Traditional IRA is a great option if you’re looking to open and fund your own retirement account. You might want to consider doing that if you:

• Don’t have a retirement savings plan at work.

• Take your retirement benefits at work but want to save more.

• Want to fund a retirement account for a spouse earning little or no income.

If you’re trying to figure out how much to save for retirement and when, we recommend that you start as early as possible and plan to save at least 10% of your income — either in an employer plan (if you have one), an IRA or both. If you’re near 30 and haven’t started saving, you need to contribute closer to 15%. The older you start saving for retirement, the more you have to save.

How to choose between a Roth and Traditional IRA

Both Roth and Traditional IRA accounts are subject to contribution limits and income restrictions, but most people qualify for them.

If you qualify to contribute to a Roth or Traditional IRA, choosing between them can be a tricky decision.

With a Traditional IRA, you can get an immediate tax benefit, making it easier to make the deposit into the account. The benefit is that some or all of the money you choose to put into the retirement account is deductible on your income tax return. You won’t pay tax on that amount. You pay taxes only when you take money out in retirement (after age 59 ½ except in special cases).

With a Roth IRA, you don’t get that up-front tax break when you put the money into the account, but you don’t have to pay taxes when you take money out in retirement. You also don’t have to pay taxes on the money in the account, as it grows.

Since we don’t know what’s going to happen in the future, we don’t know for sure which one is a better option. If your tax rate is higher now than it will be in retirement, then a Traditional IRA should work out better. If the tax rate will be higher in retirement, then the Roth IRA should be a better option. But, nobody knows what tax rates will be in the future.

You can weigh different options based on whether you:

1. Pay any taxes now.

If your tax bill is already zero, use the Roth IRA. You’ll probably get no additional tax benefit from a Traditional IRA deduction. You can play around with this when preparing your income tax return. You have until the April tax filing deadline to make IRA contributions for the past year.

2. Will have an above-average income in retirement.

If you or your spouse is on track to earn a lot during retirement, then the future tax break of a Roth is more likely to be beneficial. If you are going to get a pension through work or will have substantial retirement savings, the tax-free nature of a Roth IRA may be appealing to you. If you don’t think you’ll have a lot of income in retirement, the Roth might not pay off. Today's retirees pay little tax on average and, if that continues, the Roth might only be better for those expecting an above-average income when they retire.

3. Have taxable income over a specific amount.

If you are single and your taxable income is more $34,500, consider the Traditional IRA. If you are married and file your taxes jointly with your spouse and you make more than $69,000, consider the Traditional IRA. Those two figures are the cut-off points for the 25% tax bracket in 2011. While you still get a benefit below these income levels – and a Traditional IRA might still make sense – the 25% tax bracket is where many people really start to notice the up-front tax benefit that comes with the Traditional IRA. If you contribute $5,000, for example, you get $1,250 in tax savings.

You also want to check your state income tax bracket. You may receive noticeable tax savings there, too, so those brackets can affect your decision.

4. Worry that tax rates will go up. 

If you're worried that tax rates could go up a lot by the time you're retired, you might choose the Roth just so you have some protection against those rate hikes. We can’t know for sure, but if it gives you peace-of-mind knowing that you won’t pay taxes later, then consider the Roth IRA.

5. Are still undecided.

If you’re still undecided and don’t feel comfortable funding either the Roth IRA or the Traditional IRA alone, consider splitting your contribution between both a Roth IRA and a Traditional IRA. You have the option of funding both, as long as you don’t go over the annual contribution limit when you add the two contributions together.

How to put money into IRAs

You can open an IRA with various institutions, such as: banks, brokerage firms, mutual fund companies or life insurance companies. The biggest differences between most IRA providers are the fee structures and investment alternatives. In general, you want to look for options that are low-fee.

When picking an IRA provider, e do not recommend a full-service broker, which can cost you more in fees. Instead, we recommend you work with a mutual fund company, online brokerage or discount brokerage, which will keep your fees low. And while we don't recommend a specific IRA provider, the following sites can help you research different options:

• The Wall Street Journal (WSJ) Smart Money:www.smartmoney.com

• The Motley Fool: All About IRAs: www.fool.com/money/allaboutiras/allaboutiras.htm

• CNN: Money 101: money.cnn.com/magazines/moneymag/money101/lesson13/index.htm

When you open an account, there are two things that occur:

You put money into the account. 

We recommend automating transfers with each pay cycle, so you don’t even have to think about it.

You pick investments to fund or you get automatically funded.

If you fund your IRA through a brokerage, you put money in and decide how to invest it. We recommend you invest in mutual funds, which are long-term, stable investments.

If you go through a mutual fund company or insurance company, putting money into an IRA account means putting it into a pre-chosen investment.

If you go through a mutual fund company or insurance company, putting money in means putting it into a pre-chosen investment. With a brokerage account you put money in and then decide how to invest it (though there too, it can be some pre-chosen mutual fund). Not sure how to rework.

Most IRA providers will have a website where you can go to manage your account. You can check your balances, “fund” your account by transferring money in and pick your investments.

How to take money out of IRAs

Before we talk about withdrawing money from your IRA account, we want to mention that you can move your IRA from any firm to another one. You’re not stuck with the place you started with and, as long as you are moving your money into another retirement account, you shouldn’t pay tax penalties.

When you fund an IRA, the goal is to put money in and let it grow until you are in retirement. Any tax benefits you receive from funding your own IRA go away if you take money out of it too early.

You can start to take money out of your IRA account after you turn 59 ½. Take money out before that and you’ll have to pay penalties in addition to having to pay federal and state taxes on what you take out. We recommend putting your money into your IRA and letting it grow until after you turn 59 ½.

What are the tax benefits and rules?

IRAs are set up to give you tax benefits and they each work a little differently. Here are the basics:

Traditional IRA

Funds you put into a Traditional IRA may be tax-deductible, depending on your income and whether you have access to a 401(k), 403(b) or 457(b) Thrift Savings Plan through your employer. When you withdraw money from a Traditional IRA, you pay taxes then. You don’t pay taxes on gains and income while you are funding the Traditional IRA, because they are tax-deferred.

Roth IRAs

Funds you put into a Roth IRA are not tax deductible. However, when you withdraw money from a Roth IRA in retirement, you do not pay taxes. Gains and income on Roth accounts are never taxed, as long as you don’t withdraw them before you turn 59 ½.

Because of the unique tax advantages of a Roth IRA, there are income restrictions. If you earn more than the limit during a given year, you can’t contribute to a Roth IRA in that year. The limit is calculated based on your total modified adjusted gross income — or yours and your spouse’s combined, if you’re married.

Spousal IRAs

The IRS does not use the formal name “Spousal IRA,” though it is a fairly common nickname and you will find it on the IRS website. A Spousal IRA is just a traditional IRA or Roth IRA contribution that is based on a spouse’s income, rather than the income of the person who owns the IRA. It’s a way to fund a retirement account for a spouse who earns little or no income. In order to do this, you have to file a joint tax return that year.

The contribution limits and income restrictions for the spousal IRA are the same as for a Traditional or Roth IRA. How much you can contribute or deduct is based on factors, such as total income level or whether the working spouse has access to a retirement plan through an employer, such as a 401(k), 403(b) or 457(b) Thrift Savings Plan.

Words to know

Unsure about something you read? Many of the financial terms you came across in this article are defined in our financial glossary. A-Z Glossary

Links we like

Here are a couple online features you might find useful:

• IRAs on Investopedia: www.investopedia.com/terms/i/ira.asp

• The Motley Fool: All About IRAs: www.fool.com/money/allaboutiras/allaboutiras.htm

• WSJ Smart Money: www.smartmoney.com

• CNN Money 101: money.cnn.com/magazines/moneymag/money101/lesson13/index.htm

• IRS Publication 590 on IRAs: www.irs.gov/publications/p590/index.html