By R. Lidh

As tax time draws near, you may be looking for ways to limit what you owe Uncle Sam. One method is to put money in a Roth or Traditional IRA. The problem - most of us have no idea what makes each different or which will have the greatest return in twenty years. To help, below is an overview based on information found at http://www.irs.gov.

A Traditional IRA allows you to set aside funds for retirement in a personal savings plan such as a mutual fund or annuity.

Eligibility - If you are under the age of 70 ½ by the end of the tax year and you have earned taxable income from wages, salaries, tips, bonuses, alimony or self-employment, you are eligible to set money aside in an IRA.

Contributions - You can contribute $3000 per tax year or all of your earned income, whichever is lower. If you are over 50 years old, you may be able to contribute for missed years based on a schedule developed by the IRS.

Tax Structure - Funds contributed to a Traditional IRA are deducted from your taxable income for the year of the contribution. Once you begin to withdraw funds, presumably after retirement, the amount you withdraw from the account is taxed as part of your income.

Benefits - Your current taxable income is lowered, and your savings earn interest and/or dividends while you work toward retirement. Upon retirement, most people move into a lower tax bracket. The funds you withdraw, usually post-retirement, are taxed at the lower, post-retirement level rather than the higher tax bracket from when you were fully employed.

Withdrawals - You are eligible to make withdrawals, penalty free, after age 59 ½ and before age 70 ½. There are several exceptions to the "59 ½" rule. Taking a distribution to cover medical expenses, for a first home, for some higher education expenses or in case of disability may be allowed without a penalty. These exceptions are subject to change (and often do).

Penalties - If you withdraw funds before age 59 ½, you may be subject to an additional 10% tax. If you wait to begin withdrawals past April 1 of the year after you turn 70 ½, you may have to pay an additional excise tax.

A Roth IRA also allows you to set aside funds for retirement. Most guidelines are similar to those for a Traditional IRA
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Eligibility - If you have earned taxable income from wages, salaries, tips, bonuses, alimony or self-employment and your modified adjusted gross income is less than $110,000, you are eligible to set money aside in a Roth IRA.

Contributions - You can contribute $3000 per tax year or all of your earned income, whichever is lower. If you are over 50 years old, you may be able to contribute for missed years based on a schedule developed by the IRS.

Tax Structure - Funds contributed to a Roth IRA are not deducted from your current taxable income. You pay taxes on the money you put into a Roth IRA the year you earn the money. Once you begin to withdraw funds, the amount you withdraw from the account is not counted as part of your taxable income.

Benefits - Your taxable income, once you begin to make withdrawals, does not increase by the amount you receive from the Roth IRA. This money is "tax free" because you have already paid taxes on it. In addition, the interest or dividends you earn on your savings is also "tax free."

Withdrawals - You are eligible to make withdrawals, penalty free, after the Roth is 5 years old and you have reached age of 59 ½. You do not, however, have to make withdrawals at any age. As with a Traditional IRA, you may get funds, penalty free, to cover medical expenses, for a first home, for some higher education expenses or in case of disability. Please note rules are subject to change.

Penalties - If you withdraw funds from your Roth before it is 5 years old and before you've reached age 59 ½, you may be subject to an additional 10% tax.

At a glance, both IRAs are similar. The most significant difference is when your money gets taxed - before you start earning interest (Roth) or after (Traditional). If you are looking to lower your check to Uncle Sam come April 15, 2003, you may decide on a Traditional IRA. If you want to limit Uncle Sam's cut in 2033, you may decide on a Roth.

Or, you can choose based on which IRA will be worth most when you retire. The answer depends on many factors: time spent in the plan, total contributions and tax bracket now versus when you begin withdrawals, to name a few. Often, the difference in distribution is small. For example, someone who begins contributing $3000 a year at age 35, retires at age 67, drops from the 32% tax bracket to 18% at retirement, earns 9% interest on the IRA before retirement and 6% afterwards (and dies at age 88), can expect a projected annual income of $37,431 from a Traditional IRA and $38,143 from a Roth IRA.

Because the formulas are complicated and many of the inputs are based on predictions for your particular situation, ask your financial advisor to calculate the difference using your specific information. She will make informed estimates based on your history and future plans. If you want a general idea, you can use an online calculator, provided by many financial sites, based on the characteristics of the general population.

For more detailed information on IRAs, including examples, sample forms and updates to the tax code, visit http://www.irs.gov.