For many individuals with steadily rising incomes or who expect higher incomes in retirement than during their working lives, a Roth IRA can be a more attractive investment vehicle than a traditional IRA.
That’s because you make contributions to a Roth IRA using money that’s already been taxed. So your Roth IRA account grows tax-free, and—if you meet certain conditions—you can take tax-free withdrawals during retirement. Did you convert a traditional IRA to a Roth IRA in 2010? Call us TODAY! We may be able to save you money on your 2011 tax bill—if we reverse the conversion by Oct. 17, 2011.
But when taxes are involved, nothing’s ever simple—and a misstep can be costly. The following Q&A will help you get up to speed on Roth IRAs and avoid (or at least minimize) tax penalties.
Q: The benefits of a Roth IRA seem compelling, but how can I decide if a Roth IRA—rather than a traditional IRA—is the way to go?
A: A careful review of your portfolio is needed to answer this question. We’ll be pleased to perform this analysis for you, as we’ve done for many of our clients, during a meeting at our offices.
Q: How much can I contribute annually to a Roth IRA?
A: To contribute to a Roth IRA, you first must meet an eligibility test. If you’re single or a head of household, your modified adjusted gross income (AGI) must be less than $107,000; if you’re married, your combined AGI must be less than $169,000 for you or your spouse to be eligible for a Roth IRA. If you pass this income test and you’re under 50, you can contribute up to $5,000 to a Roth IRA in 2011; if you’re 50 or older, the top contribution you can make in 2011 is $6,000.
Want to learn more about Roth IRAs? Read on. . .
Q: Can I contribute to both a Roth IRA and a traditional IRA?
A: Yes, so long as your total contribution to the two accounts doesn’t exceed the annual limit: $5,000 if you’re under 50 or $6,000 if you’re 50 or older.
Q: What determines whether my withdrawals from a Roth IRA are tax-free?
A: All “qualified” withdrawals (called “distributions”) are tax-free. Two conditions must be met for a distribution to be considered qualified. First, the money must have been in the account for five years. Second, you must be at least 59 ½ years old, must be disabled, must have died (in which case, your heirs may take tax-free distributions) or must use the distribution (capped at $10,000) for a first-time home purchase.
If, however, your Roth IRA includes funds that you’ve rolled over (converted) from a traditional IRA and five years haven’t passed since the conversion date, your distributions at age 59½ and older will be taxable until you’ve received the principal amount you converted plus the earnings. So it’s important to carefully consider the tax consequences before converting a traditional IRA to a Roth IRA after the age of 54½. The heftiest tax impact is that, regardless of your age when you convert all or some funds in a traditional IRA to a Roth IRA, you must pay taxes on the conversion amount with your tax filing for that year.
Q: If I withdraw money from my Roth IRA before I’m 59½—so the distributions won’t be “qualified” and therefore won’t be tax-free—what will the tax implications be?
A: If you aren’t disabled and aren’t withdrawing the money (up to $10,000) for a first-time home purchase, you can make withdrawals from your Roth IRA account before age 59½ only if the account has conversion funds that you’ve rolled over from a traditional IRA. But you’ll pay a tax penalty. If the conversion took place less than five years prior to the withdrawal, the penalty will be assessed on the principal and earnings. If at least five years have passed since the conversion, the penalty will be assessed on the earnings only.
Q: My investment choices at work included a Roth 401(k), which I decided to fund through regular deductions from my paycheck. Can I roll my Roth 401(k) over to a “plain-vanilla” Roth IRA?
A: Yes, but the five-year rule on taxes (see above) will apply to the distributions you take from the Roth IRA. It’s a bit complicated, so we recommend that you set up an appointment with us to discuss the pros and cons of converting a Roth 401(k) if you have one or plan to start one. As a general rule of thumb, however, the earlier you start a “plain-vanilla” Roth IRA—if you’re eligible to do so—the better.
