Roth IRA and its Benefits

We thought we would all be in lower tax brackets when we retired; therefore tax deferral was the plan. However, tax rates are likely to be as high when we retire as when we are working; therefore the benefits of a Roth IRA become more attractive.A Roth IRA is a retirement plan that allows individuals to make tax-deductible contributions of $4000, to the extent of their earned income. This means individuals may contribute the lesser of income they have earned during a particular tax year or $4000. Contributions made to a Roth IRA are made after-tax (meaning they are not tax deductible when made). These contributions, and any growth in the value of the Roth IRA, are tax-free forever.Under the tax laws applicable to Roth IRAs, your contributions must be made as an individual taxpayer; however, they are not taken as a tax deduction on your individual income tax return (From 1040).Since its inception in 1997, the Roth IRA has become a hugely popular investment vehicle. Like the traditional individual retirement account, the Roth IRA is a personal savings plan that offers tax advantages to set aside money for retirement.Investments in a Roth IRA compound tax deferred, but what provides a unique advantage for the Roth IRA is that, once an individual has reached the age of 59% and his or her account has existed for more than five years, all withdrawals are tax-free.Roth IRAs for the taxable year can be opened and/ or funded any time prior to the due date for your individual Form 1040 tax return, excluding extensions. This means any time prior to April 15 of the calender year following the tax year in which the deduction is being considered. This due date is applicable to both deductible and non-deductible Roth IRA contributions. Just remember, filing for an extension of time does not extend the time period allowed for contributions.Earned IncomeYou can qualify to participate in a retirement plan if you have earned income (compensation) for the tax year in question under the following conditions:If you earned profit in your businessIf you paid yourself wages as an employee of your businessIf you paid yourself guaranteed payments – even if your business earned no profitsContributionsYou can contribute up to a maximum of $4000 every year ($4500 if you’re age 50 or over), up to hte extent of 100 percent of your earned income every year, unless you are prohibited from contributing that year because you generated too much modified adjusted gross income (MAGI) during that year and are therefore subject to the MAGI.Anyone who has earned income and falls within the MAGI limits can establish a Roth IRA. Unlike the traditional IRA, the Roth IRA has no age limit for contributions, so individuals can continue ot contribute as long as they like. (Note: In a traditional IRA, individuals can contribute only until age 70%)Contribution to a Roth IRA are not tax deductible. Your contribution is made with after – tax dollars. However, the advantage of the Roth IRA is that you will never pay taxes on your earnings or withdrawals (distributions) as long as you have reached the age of 59.5 and your account has been open for at least five years. Annual contributions can be taken out at any time with no tax consequences. All other funds (e.g., earnings, conversion funds) can be taken out penalty-free if the account has been established for five years and the individual is over the age of 59.5. Non contribution funds taken out without meeting these requirements are taxable and subject to a 10 percent penalty. Furthermore, there are no mandatory withdrawal requirements, as there are for traditional IRAs.Modified AGI LimitsYou may contribute to a Roth IRA if you have taxable compensation and your modified adjusted gross income (Magi) is less than $110,000 ($160,000 if you are married and file a joint return, and $10,000 if you are married, lived with your spouse, and file a separate return). The amount you may contribute to a Roth IRA is gradually reduced of your MAGI is between $95,000 and $110,000 (between $150,000 and $160,000 if you are married and file a joint return, and between $0 and $10,000 if you are married, lived with your spouse, and file a separate return).The amount you may contribute to a Roth IRA is reduced by contributions you make to a traditional IRA. The amount you may contribute to a Roth IRA also may not exceed your taxable compensation. You may continue to make contributions to your Roth IRA after reaching age 70.5.

Roth IRAs in 2010 Part 2

401k rollover to Roth IRA for married couple both age 60, Does it make financial sense?

With the new rule in effect as of March 2008 allowing a direct 401k rollover to Roth IRA, could you shed some light on this scenario: A couple, both over 60 files jointly and will be earning less income when retired. Currently both are working and earn 100,000. When retired their income will be 46,000. They have 300,000 combined in their 401k and would like to know if it makes financial sense to rollover to a Roth Ira. Thank you for your help.

Roth Conversion 2010

Potential pitfalls of converting to a Roth and what it could mean for your finances.

Roth IRAs in 2010 Part 1

can I fund my spsousal Roth IRA from my rollover?

I am close to retiring & want to know if I can fund my Roth IRA with withdrawals from my rollover. I do not work now but my spouse does.

Roth Iras: Test your Knowledge

How well do you know Roth IRAs? Here are five tough questions. Let’s see how you do…

1. I am 72 years young and still working. Can I set up a Roth IRA?

Yes. Unlike a traditional IRA, which does not allow contributions past age 70 1/2, Roth IRAs have no age limitations. You can continue to contribute to your Roth as long as you have compensation.

2. I am married, age 57, file a joint tax return and make $65,000. I am a participant in a 401(k) plan at work and put $5,000 into my own traditional IRA. Can I set up a Roth IRA?

Not in the tax year in question. You already put your regular contribution limit ($4,000) into your traditional IRA along with another $1,000 catch-up contribution which is allowed because you are over age 50. In your case, you have made the maximum IRA contribution. If you put less into your traditional IRA, you could put the difference, up to $5,000, into a Roth IRA.

3. I am single and my modified adjusted gross income for 2006 was $115,000. I have an existing Roth IRA. Can I make a contribution for 2006?

No, you made too much money. For 2006, if your modified adjusted gross income was less than $95,000, you could make a full contribution to your Roth IRA. The rules say if it was more than $110,000, you cannot make any contribution. If it was between $95,000 and $110,000, there is a formula to calculate a partial contribution limit.

If you were married and filed a joint return, you could have made up to $150,000 and made a full Roth IRA contribution. If you were married and your modified adjusted gross income was over $160,000, no contribution would have been possible. For incomes falling between these numbers, a partial contribution determined by a formula could have been made.

Also note the income limits are now indexed; they will be higher in 2007 and beyond.

4. I have an existing traditional IRA and I want to roll it over to a Roth IRA. Is this possible?

It depends on four things: What year it is, how much money you make, your marital status and the type of income tax return you file. If you are talking about a tax year before 2010 and your adjusted gross income exceeds $100,000 or you are married and file a separate return, you can’t convert your traditional IRA to a Roth. Period.

After 2009, these limitations don’t apply and you are good to go. Moreover, you can spread the income tax due on the rollover over tax years 2011 and 2012.

5. I am 55 and have had my Roth IRA for 3 years. I just went on disability and need to withdraw a good portion of it. Is the withdrawal taxable? And since I am not 59 1/2 do I have to pay the 10% penalty tax?

Your Roth IRA consists of two elements: your contributions and earnings. You can take out any amount up to your total contributions tax free.

In order for any earnings withdrawal to be tax free, the distribution has to be a “qualified distribution”. To be qualified, the distribution needs to be made after five taxable years starting with the first Roth contribution.

Then assuming this five year rule is satisfied, you can take out money tax free if you are over age 59 1/2, disabled, or to buy a first home for yourself, your spouse, children or grandchildren ($10,000 maximum). The rules go on to say if you die and your spouse elects to treat your Roth IRA as their own, any distributions would be qualified.

Distributions before age 59 1/2 are subject to a 10% premature penalty tax. However, this tax only applies if the distribution is includable in income. If you take out your contributions, these are not taxed.

In your case, you qualify for one of the exceptions: disability. So there is no 10% penalty tax.

These examples are based on my interpretation of the rules and should not be relied upon as tax advice. The complexities of distributions from any qualified plan or IRA underscore the necessity to consult with a qualified tax professional prior to making any withdrawal.

Is it possible to borrow from a rollover IRA or Roth IRA to refinance a home?

If so, what are the consequences and/or penalties?

Are there any tax advantages in converting a rollover IRA into a Roth IRA?

As I understand it, if I convert the rollover into a Roth, I will then have to report the entire amount on my taxes as income the year I do the conversion. So after “x” number of years when I’m ready to start taking money out of my Roth, won’t I get taxed again? Am I setting myself up to let the IRS tax me twice on some of the same money?

Roth IRA Conversion – Pros and Cons

Effective January 2, 2010, Roth IRA conversions are no longer limited by an earnings test. With this earning test eliminated many financial professionals are advising individuals to convert their traditional IRAs into Roth IRAs. But is a Roth IRA conversion right for everyone? In this article we will explore the pros and cons of doing a Roth IRA conversion.

Overview

Traditional IRAs allow individual who qualify, to make a tax deductible contribution. When it comes time to make qualified distributions, these distributions are taxed at whatever your effective tax rate might be in the year of the distribution. Roth IRAs allow individuals who qualify to make contributions which are not tax deductible. When qualified distributions are made from a Roth IRA, such distributions are tax-free.Often, individuals who change jobs or are terminated have the option of rolling their retirement plan funds into an IRA. In the past, most individuals have rolled these retirement funds into traditional IRAs (rollover IRAs). Effective January 2, 2010, individuals with traditional IRAs (rollover or otherwise) are eligible to convert their traditional IRAs into Roth IRAs, irrespective of their level of income.

Pros of a Roth Conversion:

1. Tax-Free Distributions – Qualified Roth IRA distributions are never subject to federal income tax. Roth IRAs represent a hedge against future tax increases; 2. No Required Minimum Distribution – Traditional IRAs have a requirement that distributions must begin in the year an individual turns 70 1/2 (or by 4/1 of the year following the year an individual turns 70 1/2). This is called a Required Minimum Distribution. Roth’s have no Required Minimum Distribution requirement. Thus, there is no requirement to withdraw any Roth funds during one’s lifetime; 3. Reduction in Taxation of Social Security Benefits – Because qualified Roth IRA distributions are tax-free, you can reduce the amount of your Social Security benefits which are subject to income tax. Generally, the amount of Social Security benefits which are subject to income tax are tied to the amount of other types of taxable income you receive during the year. By converting traditional IRAs into a Roth, you can reduce your future taxable income and, thus the amount of Social Security benefits which are taxable; 4. Penalty-Free Withdrawals – Taxpayers can withdraw the converted amounts without penalty after five years; 5. Benefits taxpayers most who expect to be in a higher tax bracket at or near retirement age; 6. If the taxpayer’s traditional IRA has lost value recently, converting to a Roth IRA can be done at a lower tax cost; 7. Benefits taxpayers most who have a long time horizon and will not need to withdraw from their converted Roth for some time; 8. Provides an income tax-free legacy for your heirs; 9. The tax on 2010 conversion amounts may be paid 50% in 2011 & 50% in 2012 (deferred).

Cons of a Roth Conversion:

1. For taxpayers who expect to be in a lower tax bracket at or near retirement, the tax benefit of a Roth IRA may be reduced; 2. If the taxpayer does not expect to live very long then the stretch/legacy/tax benefits of the Roth IRA will be reduced; 3. Roth conversions come with a tax cost. Payment of the tax on conversion should be from available cash, and not from the IRA itself, as such a distribution will be subject to a 10% penalty, if the taxpayer is under 59 1/2, as well as income tax on the distribution.

Best Candidates for a Roth Conversion

Some taxpayers benefit from a Roth conversion more than others. The best candidates for a Roth conversion include:

1. Wealthy Taxpayers; 2. Taxpayers seeking to reduce estate settlement costs; 3. Taxpayers who will not need to withdraw from the converted Roth IRA for some time; 4. Young taxpayers who are high-income earners; 5. Taxpayers who believe they will be in the same or a higher tax bracket in retirement.

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