Retirement: Roth IRA
The Roth IRA is similar to a regular IRA
with a few notable distinctions. The Roth IRA was created in January 1,
1998. Simply defined, a Roth IRA is a modified individual retirement
account (IRA) in which a person can set aside 'after-tax income' up to a
specified amount each year as determined by the US Government. Earnings
your Roth IRA are tax-free, and you may make tax-free withdrawals after
the age 59 1/2.
Generally speaking, a Roth IRA invests in securities, which typically
consists of common stocks or mutual funds, but could also include other
types of securities as well. All IRAs have specific eligibility and
filing status requirements which are mandated by the IRS.
Advantage of a Roth IRA:
The main advantage of a Roth IRA's is its tax structure in the eyes of
the IRS.
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Individual contributions to a Roth IRA are
made from income you've already earned (ex: income that has already
been taxed and is not tax deductible), with the advantage being that
withdrawals up to the total of your contributions are federal income
tax free, and withdrawals of earnings (anything above the total of
your contributions) are usually federal income tax free as well.
-
On the flip side, individual contributions
to a traditional IRA may be tax deductible if you meet certain
eligibility requirements, but also consider that if you withdraw money
from your traditional IRA it included as traditional income and
subject to normal income tax.
Disadvantage of a Roth IRA:
The main disadvantage of a Roth IRA when you compare it to a traditional
IRA is you're your contributions are NEVER tax-deductible with a Roth
IRA.
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Let's say you contribute $3,000 to a
traditional IRA while paying into a high tax bracket, usually you can
expect to receive a tax deduction, substantially reducing the initial
cost of contributing, but unfortunately you can't do this with a Roth
IRA. So if you're not able to max out your IRA contributions, and you
end up in a lower income tax bracket at retirement, you would
theoretically end up with less cash by choosing a Roth IRA over a
Traditional IRA.
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Consider that there are also severe
penalties for early withdrawals of your earnings if you go with a Roth
IRA. If you make an unqualified early withdrawal of your earnings this
will result in federal income tax plus a ten-percent (10%) penalty on
unqualified amount withdrawn. The good thing is there are many
exceptions, like purchasing a home for the first time and paying
certain educational expenses.
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Additionally, there is always the risk
that Congress may opt to tax earnings on Roth IRAs over the next few
decades.
Differences between regular IRA's and Roth
IRA's:
Contributions:
Contributions are made with after tax dollars. This
distinction is the most major difference between traditional and Roth
IRAs. The contribution limit
for both Roth and Traditional IRAs is the same. You may choose to
contribute to both Traditional and Roth IRAs, but your total
contribution may not exceed the maximum annual contribution for that
year. For tax year 2004, you may contribute up to 100% of your
compensation (such as salary or wages) or $3,000 whichever is less.
You are allowed to make an additional $500 catch-up contribution if you
are age 50 or older by the end of the 2002 tax year. You may not make a contribution to a Traditional
IRA after and including the year you reach age 70 ½. For Roth
IRAs, there is no age limitation.
|
Maximum Annual Contribution |
|
Single |
Couples |
$3,000
for 2004
$4,000 for 2005-2007
$5,000 for 2008 |
$6,000
for 2004
$8,000 for 2005-2007
$10,000 for 2008 |
The Roth IRA holder can make a
contribution to their IRA for the amount of earned income they have per
year up to a maximum of $3,000 or $3,500 depending on their age.
Individuals may contribute up to $3,000 per year if they are under 50
years of age and $3,500 if they are over 50 years old. If their adjusted
gross income is $95,000 or less if they are single and $150,000 if they
are married filing a joint tax return they are eligible to contribute
the full amount. If an individual's modified adjusted gross income is
between $95,000 and $110,000, the contribution amount is less, and is
subject to certain adjustments. If the IRA holder is married filing a
joint tax return and their modified adjusted gross income is between
$150,000 and $160,000, the contribution amount is less and is subject to
certain adjustments. If you fall within these ranges, you will need to
contact your tax advisor to determine what amount you are eligible to
contribute.
Splitting Your Contribution:
If you are eligible to contribute to both type of IRAs, your
may divide your contributions between your Roth and Traditional IRAs;
however, you must ensure that the total contribution to both IRAs does
not exceed the limit for the year, ie. $3,000 for 2002 (plus $500
catch-up contribution). If you decide to split your contributions
between both types of IRAs, you may choose to contribute the
deductible amount to your Traditional IRA and the balance to your
Roth IRA. Let’s assume for example that the maximum amount you can
deduct for the 2002 tax year is $2,000. You may contribute $2,000 to
your Traditional IRA and the balance of $1,000 to your Roth IRA. Before
making such a decision, however, you must take into consideration
additional fees, such as maintenance fees charged by your IRA
Custodian/Trustee, that could result from maintaining two separate IRAs.
Note also that combining assets, by placing bulk trades into one IRA
instead of placing separate trades in separate IRAs, could help you save
on trade-related fees. Simply put, consider the short-term benefits as
well as the long-term benefits and decide which outweighs the other.
Some
taxpayers may contribute to a Traditional IRA and elect not to claim the
tax deduction even though they are eligible to do so. The benefit of not
taking a deduction is that the distribution of the same amount is tax
and penalty free. The earnings, however, will be treated as taxable
income. Further, being able to deduct your IRA contribution does not
mean that you must establish and fund a Traditional IRA. You may forgo
the tax benefit of taking a deduction in order to realize the benefits
of a Roth IRA, such freedom from the RMD rules and tax and penalty-free
distributions.
Income Limitations:
To your Roth or Traditional IRA you may contribute the lesser
of 100 percent of your year's compensation or $3,000. However, Roth IRA
has phase out levels for contributions as outlined on the below
table. If your Adjusted Gross Income is above $110,000 for individual
or $160,000 married couples, no contributions can be made to a Roth IRA.
However, a contribution can still be made to a Traditional IRA at higher
income levels, but the contribution may not be deductible.
|
Adjusted Gross
Income (AGI) Limits
On Contributions to a Roth IRA for 2002 |
|
AGI Limits |
Single |
Couples |
|
Full contribution
|
$95,000 & below |
$150,000 or below |
|
Partial contribution |
$95,001 - $110,000 |
$150,001 - $160,000 |
|
No contribution |
$110,000 & above |
$160,000 & above |
Eligibility:
Unlike the traditional IRA, there is no 70 1/2 age limit on making
contributions. The individual simply needs to have earned income equal
to the amount contributed up to a maximum of $3,500.
Distributions
From Your Roth
IRA
Withdrawal from Roth IRA
accounts are tax-fee and penalty-free if it's a qualified distributions.
To qualify for a penalty-free and tax-free distribution under a Roth
IRA, the account must be held for at least 5 years. This five-year
period begins with the tax year for which the first contribution is
made. For example, if you make a Roth IRA contribution in April 2003 for
tax year 2002, your five-year period begins January 1,2002, because the
contribution was made for 2002. In addition to the 5-year holding rule,
penalty-free and tax-free distributions may be made at age 59 1/2, and
early withdrawals (before age 59 1/2) may be taken penalty-free and
tax-free (up to $10,000) if the money is used to pay for a first time
home purchase. Unlike traditional IRAs, you are not required to take
minimum distributions after age 70½; if you do not need income from your
Roth IRA, you can let your money continue to grow tax-free. Your
beneficiary, however, must take required minimum distributions.
Converting To Roth IRA
Traditional IRAs can be converted to a Roth IRA. However, there are
some qualifications that must be met, and investors should carefully
assess, with a qualified advisor, whether the conversion would
beneficial.
Next-->>
What is a Rollover
IRA?
Inflation is when you pay
fifteen dollars for the ten-dollar haircut
you used to get for five
dollars when you had hair.
-- Sam Ewing --
Table of
Contents:
-
What Are Retirement Accounts?
-
Employer Based
Retirement Plans
-
401(k) Plans
-
Individual Retirement Accounts (IRAs)
-
Roth IRA
-
The Roth IRA:
Early Withdrawals
-
What is a Rollover IRA?
-
Converting and
Recharacterizing of an IRA
-
Education IRA & SEP IRA
-
Self Employed Retirement plan: Keogh
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