These days, most people know that saving for
retirement is a personal responsibility and a necessity. One versatile
savings alternative that offers a variet of tax benefits is the
Roth IRA. The Roth IRA differs from the traditional IRA in several
important ways. Many individuals, however, are still a bit unsure
as to how the Roth IRA might fit into their overall financial plan.
With this in mind, here's a quick review of this versatile savings
vehicle.
Who is Eligible?
At first glance, the biggest advantage of a Roth IRA appears to
be that contributions and earnings can be withdrawn free of income
taxes. Unlike a traditional deductible Individual Retirement Account
(IRA), contributions to a Roth IRA are made on an after-tax basis.
As a result, no income tax is due when distributions are taken
from Roth IRAs.
You're eligible to make a full contribution to a Roth IRA if your
adjusted gross income (AGI) does not exceed $95,000 for single
taxpayers or $150,000 for married taxpayers filing jointly (contributions
to a Roth IRA are phased out for single filers with AGI between
$95,000 and $110,000 and for joint filers with AGI between $150,000
and $160,000). You can also contribute to a Roth even if you are
a participant in a 401(k) or other employer-sponsored qualified
retirement plan. However, please note that contributions to a Roth
IRA may be limited if you are also contributing to a traditional
IRA. Combined contributions for Roth IRAs and traditional IRAs
may not exceed $4,000 in 2005.
Contributions and earnings can be withdrawn from a Roth IRA free
of income taxes after the account has existed for 5 years and when
you reach age 59½. If you take withdrawals prior to age
59½ you may be subject to a 10% federal income tax penalty.
However, certain situations qualify as exceptions, such as early
withdrawals made to pay for first-time home purchases or qualified
education expenses.
An Addition to Your Plan?
You'll need to carefully analyze your
own unique situation to determine if there are any long-term benefits
to using a Roth IRA
as opposed to an expanded deductible IRA. The Roth IRA appears
to be of greatest benefit if you are a participant in a qualified
plan (such as a 401(k)) and your AGI exceeds the expanded deductible
IRA income limits ($50,000 - $60,000 for single taxpayers and $70,000
- $80,000 for married taxpayers filing jointly for 2005), but you
do not exceed the income limits for a Roth IRA. In addition, you
may also benefit if you are setting money aside for the purchase
of a first home.
Should You Convert to a Roth?
Traditional IRAs can be converted
into Roth IRAs as long as adjusted gross income does not exceed
$100,000. However, rolling your traditional
IRA into a Roth IRA does come with a price. Any deferred income
taxes from your existing IRA (the one you will be converting) will
be due in the tax year in which the conversion occurs. In addition,
paying income taxes from the existing IRA proceeds at the time
of the Roth conversion will be considered an early withdrawal if
made prior to age 59½ and may be subject to a 10% federal
income tax penalty. Therefore, if you are younger than age 59½,
you will need to pay a potentially substantial income tax from
out-of-pocket sources to avoid the 10% penalty tax.
If you're thinking about converting an existing IRA into a Roth,
be sure you seriously consider the following:
- When you expect to need the IRA proceeds;
- Your ability to
pay the income tax due in the year of conversion from an
alternative source;
- Whether the additional tax incurred
at the time of conversion will place you in a higher tax
bracket, which could result
in a greater than expected income tax liability; and
- Whether
or not converting will benefit your long-term bottom line.
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Other Positive Considerations
In addition to tax-free withdrawals,
two of the more intriguing features of a Roth IRA are that 1) there
are no Internal Revenue
Service (IRS) restrictions on when you must begin taking withdrawals
(i.e., age 70½ with traditional IRAs); and 2) you can continue
to contribute to a Roth beyond age 70½ if you have earned
income. Over the long term, this can lead to the potential for
significant additional savings, especially if you plan to work
past age 70½ or if you have other sources of retirement
income and do not expect to heavily rely on your Roth IRA for income.
As an added benefit, your Roth IRA beneficiary may also continue
to enjoy the benefits of tax-free withdrawals over his or her life
expectancy, as long as withdrawals commence before December 31st
of the year after your death. (Note: If your beneficiary does not
begin taking withdrawals by December 31st of the year after your
death, the entire Roth IRA proceeds must be withdrawn by December
31st of the fifth anniversary of your death |
