The major difference between traditional IRAs and Roth IRAs is tax treatment. A traditional IRA allows you as the owner to deduct part of your contributions from your taxes now, but you pay taxes on the money you take out of this type of IRA later. A Roth IRA, on the other hand, does not provide a deduction on your current taxes, but the distributions – the money you take from any type of IRA – are tax free.
There are certain income exclusions that prevent some people from opening IRAs, but in general, most people can have either type. While some people will try to figure out which of the two they should open based upon their income and tax outlook, my recommendation is to open both types as and when needed, and save up your contributions for the year in a savings account to deposit in your IRA all at once after you’ve calculated your taxes for the year.
This is what I’ve done. For the most part, I do not pay enough in federal taxes to benefit from deducting traditional IRA contributions, so I contribute to my Roth IRA instead. However, in years where I’ve had a significant spike in income due to a one-time event, such as when I sold a rental property in 2004, I contribute to my traditional IRA and thereby shave some off of my tax bill.
To do this, I do not put my money into my Roth or my traditional IRA throughout the year, instead setting it aside in a savings account until after I calculate my federal income taxes. The reason I do so is that contributions can be made for the prior calendar year up until April 15th of the current year. In 2005, when I was working out taxes for 2004, I calculated a large tax bill was due to the IRS because of the property sale I mentioned previously. Since I had set aside money for my IRAs but not actually put it in either one, I was able to make a retroactive 2004 deposit to the IRA account that was most advantageous to me at the time. Doing this reduced my total tax bill that year by $900.
In summary: own both type of IRAs, Roth and traditional; set aside your IRA contributions in a savings account, not in the IRAs themselves; in the following year, once you’ve calculated your taxes for the previous year, deposit your saved up IRA money into either your Roth or your traditional IRA as a prior year contribution depending on what would serve you better.