Roth IRA

If you are looking for a way to save towards your retirement then you should consider getting a Roth IRA (Individual Retirement Account) or get a 401K that both large and small businesses offer their employees. After setting up you have the right to start making contributions towards it. But when making IRA contributions you need to be aware of certain things and below we take a look at what these are in relation to a Roth IRA.

Firstly how much a person is able to contribute depends on their age. Anyone under the age of 50 can contribute $4,000 while those over 50 are entitled to contribute $4,500. There are no limitations on the age at which people are able to contribute to their Roth IRA plan. But 401k contribution limits vary considerably from those offered to you with an IRA.

One thing to be aware of when making contributions to a Roth IRA is the restrictions on what your gross taxable earnings can be. An individual must earn less than $110,000 per year. For a married couple who file a joint return the gross income must not exceed $160,000. And for couples, who file their returns separately,their combined gross income must not be above $100,000.

You need to be aware that your Roth IRA contributions will be reduced when you are actually contributing towards a traditional IRA as well. So if you are making contributions to both a Roth and Traditional IRA these should not exceed the total amount of contributions you are allowed to make in any given year. But with Roth IRA’s the contributions you make on these will be reduced if your income goes above a certain limit.

However you can use the conversion method to allow you to contribute towards a Roth IRA when you have a traditional one. All you have to do is take out some of the funds from your traditional IRA and then transfer these funds within 60 days into the Roth IRA. Although when you make Roth IRA contributions you are taxed on them. Any withdrawals made or funds distributed are not taxable.

You are not restricted to when you can make contributions to an IRA. But you must make sure that these contributions are made before you file your tax return even if you have been provided with an extension. Because IRA contributions are not tax deductible these should not be listed on a tax return.

As you can see from doing a little investigation just how important Roth IRA’s can be to making your retirement a financially stable one. So when planning your retirement you need to consider just how important getting an IRA is to it.

Above we have provided you with details regarding Roth IRA contributions and what things you need to be aware. It is also advisable that you discuss the matter with your financial adviser as they can help to ensure that you select the right one that will ensure that your retirement is a much happier one as well as being a more financially sound investment as well.

Want to make lemonade from the lemons in your IRA? This year’s market tumble has handed you a recipe.

Usually IRA owners can’t take advantage of capital losses on their stocks and funds. Since earnings aren’t taxed year by year in such a retirement account, there’s no point harvesting losses to offset gains.

That maneuver only works for shareholders in their taxable accounts.

But this year offers you a special opportunity. It involves converting a traditional IRA to a Roth IRA, which takes after-tax contributions but allows tax-free compounding of investments as well as withdrawals.

Any year that you convert a traditional IRA to a Roth IRA, you owe income tax on the amount transferred. The silver lining to 2008’s cloudy market performance is this: If your IRA assets have been devalued by the bear market — and whose haven’t been? — you’d owe less tax on any conversion.

You’re eligible to convert if your modified adjusted gross income this year, for marrieds filing jointly or singles, is $100,000 or less.

To do a conversion, tell the mutual fund group or bank that is your IRA custodian what you’d like to do. You’ll have to fill out some forms.

Here’s an example that shows the advantage of a Roth IRA conversion now. Suppose a hypothetical Sue Adams retired at the end of 2007. Her MAGI this year is $95,000.

At the beginning of 2008, Adams rolled her 401(k) account into a traditional IRA. Her IRA was invested in stock funds worth $800,000.

If Adams had converted her traditional IRA to a Roth IRA in January 2008, she would have reported $800,000 of ordinary income. The $800,000 in income from the Roth IRA conversion does not count for determining if Adams is over the $100,000 MAGI limit. Assuming an effective 35% tax rate, Adams would have owed $280,000 in income tax on her conversion.

Lower Levy

Instead, Adams chose to keep her traditional IRA. Now those stock funds are worth only $500,000.

If she can convert to a Roth IRA now, at a 35% rate, Adams would owe only $175,000. So she’d save $105,000 in tax vs. converting her IRA early in the year.

Adams would still pay tax now. Why would she want to pay so much tax before it’s required?

Because once she’s 59 1/2 and her account is five years old, she can withdraw her principal and earnings tax free.

All Roth IRA conversions in 2008 have a Jan. 1, 2008, starting date, notes Ed Slott, a CPA who publishes the IRA Advisor newsletter.

So the five-year mark will be reached on Jan. 1, 2013, just over four years from now.

Suppose Adams’ stock funds have rallied by then and her Roth IRA is back up to $800,000. She can withdraw all of it, including $300,000 of growth, and owe no more tax.

Adams does not have to convert the entire $800,000. She can convert part of it and owe tax only on the amount she converts.

Adams might convert another part in early 2009, if her MAGI for the year won’t exceed $100,000. If her stock funds are still depressed, she will owe relatively little tax for that conversion in 2009.

And she’ll have more low-priced stock funds in position for tax-free gains within her Roth IRA if the market recovers.

Nearly 170,000 taxpayers converted traditional IRAs to Roth IRAs in 2004, the latest year for which data is available. The total amount was over $2.8 billion.

What if you converted to a Roth IRA early this year, when your stocks and funds were worth much more than now?

You can undo the original conversion — known as recharacterizing. Now, if you convert a second time you’ll owe less tax. But IRS rules require you to wait until the next calendar year before doing the second conversion.

You could even delay the recharacterization. A 2008 Roth IRA conversion can be recharacterized up to Oct. 15, 2009, Slott says.

You can reconvert to a Roth IRA 30 days after recharacterizing or on or after Jan. 1 of the year after the conversion, whichever comes later.

Suppose Adams converted her IRA to a Roth IRA in January 2008. She recharacterizes in November 2008, reversing the conversion.

On Jan. 1, 2009, she can reconvert the account to a Roth IRA. But if Adams recharacterizes in December 2008, she’ll have to wait 30 days before reconverting.

Either way, she may owe less tax than she owed on her earlier conversion. That assumes her stock funds don’t make a big comeback by the earliest date in January when she can reconvert.

If stock funds continue to decline, any conversion to a Roth IRA now can be recharacterized by Oct. 15, 2009.

You can recharacterize and aim to reconvert each year at or near the market bottom. Then you’ll pay less tax and have more opportunity for tax-free growth.

With less than two months to go before 2009, I though it would be worth taking a look at IRA contribution limits for 2009. As of 2008, contribution limits are indexed to inflation and will increase in $500 increments (as necessary). Unfortunately, there’s not much to report here, as the limits are staying the same in 2009 as they were in 2008. What follows is a table of contributions limits starting back in 2002, and running through next year.

The silver lining here is that the cutoffs for making Roth IRA contributions and for deducting Traditional IRA contributions have increased 2009.

Roth IRA Contribution Thresholds

If you’re married and filing jointly, you can make your full Roth IRA contribution as long as your modified adjusted gross income (MAGI) is below $159k, and your ability to contribute phases out entirely at $169k. For single filers, the thresholds are $101k and $116k.

Traditional IRA Deduction Thresholds

If you’re married and filing jointly, you can make deduct your full Traditional IRA contributions as long as your modified adjusted gross income (MAGI) is below $85k, and your ability to deduct contributions phases out entirely at $105k. For single filers, the thresholds are $53k and $63k.

Deadlines for Contributing

Remember, you can make 2008 contributions all the way up to April 15, 2009. As for 2009 contributions, you can start as early as January 2nd, 2009 with a deadline on the back end of April 15, 2010.

Q. I intend to retire at age 50. When I do, I’ll need income. Can I take money from my Roth IRA without paying any taxes or penalties?

A. Potentially, yes. Under the IRS ordering rules, you are allowed to remove your original contributions at any time without tax or penalty. In addition, after you’ve waited at least five tax years, you’re able to withdraw your original converted amounts without taxes or penalties. It’s only when you get to the earnings generated by the original contributions and conversions that you will have a tax and/or penalty problem.

Even if you do determine that you’ll have to break into the earnings prior to age 59-1/2, you may still avoid the penalty (but not necessarily the tax). If you remove the funds from your Roth IRA account using a distribution method that is part of a scheduled series of substantially equal periodic payments made over your life expectancy (and the life expectancy of your beneficiary), you may still be penalty-free.

You must receive taxable compensation during the year To contribute to an IRA (Roth or traditional), you must receive taxable compensation during the year. For purposes of IRA contributions, taxable compensation includes wages, salaries, commissions, self-employment income, and taxable alimony or separate maintenance. Other taxable income, such as interest earnings, dividends, rental income, pension and annuity income, and deferred compensation, does not qualify as taxable compensation for this purpose. Your contribution for a given year cannot exceed your taxable compensation for that year.

Tip: The 2006 Heroes Earned Retirement Opportunities (HERO) Act allows members of the Armed Forces to include nontaxable combat pay as part of their taxable compensation when determining how much they can contribute to an IRA (their own or a spousal IRA) in tax years beginning after December 31, 2003. Prior to the Act, a serviceman or woman with only nontaxable combat pay was unable to make an IRA contribution. Service members have until May 28, 2009, to make retroactive IRA contributions for 2004 and 2005, and will have at least one year following the date of their contribution to claim any credit or refund that they may be entitled to for those years. For service members with only nontaxable combat pay, Roth IRA contributions will generally make more sense than nondeductible contributions to a traditional IRA.

Your ability to make annual contributions depends on your income and filing status If you file your federal income tax return as single or head of household and your MAGI for 2008 is $101,000 ($99,000 for 2007) or less, you can make a full contribution to your Roth IRA. Similarly, if you file your return as married filing jointly or qualifying widow(er) and your MAGI for 2008 is $159,000 ($156,000 for 2007) or less, you can make a full contribution. Otherwise, your allowable Roth IRA contribution is reduced or eliminated as follows:

*These income ranges are indexed for inflation each year.

If you are married filing a joint return, you may be able to contribute to a Roth IRA for your spouse even if he or she has little or no taxable compensation. If you are married filing separate returns and you lived apart from your spouse at all times during the taxable year, you are treated as a single taxpayer for purposes of the Roth IRA rules.

Tip: To calculate the exact amount of your allowable Roth IRA contribution, a step-by-step worksheet is available. See IRS Publication 590, Individual Retirement Arrangements (IRAs). Tip: These income limits don’t apply to rollover contributions to your Roth IRA.

You must not have already contributed the annual maximum to your traditional IRA Total contributions to all of your IRAs (traditional and Roth) cannot exceed $5,000 for 2008 ($6,000 if you’re age 50 or older). If you contribute the maximum allowed to your traditional IRA for any year, you cannot contribute to your Roth IRA at all for that year. If you make a partial contribution to your traditional IRA, your allowable Roth IRA contribution for that year is equal to the difference between the annual IRA contribution limit and the amount contributed to your traditional IRA (or vice versa).

Example(s): You have a traditional IRA and a Roth IRA. You contribute $2,900 to your traditional IRA for the year. You can contribute no more than $2,100 to your Roth IRA for that year ($3,100 if age 50 or older). Caution: The Pension Protection Act of 2006 provides that an active reservist or guardsman who receives a qualified reservist distribution can repay all or part of that distribution to an IRA at any time during the two year period beginning on the day after active duty ends (or, if later, the two year period beginning August 17, 2006). The regular IRA contribution limits don’t apply to these repayments. A qualified reservist distribution is a payment from an IRA, or a payment of elective deferrals and earnings from a 401(k) plan or 403(b) plan, to an active reservist or guardsman who is called to duty after September 11, 2001, and before December 31, 2007, for a period in excess of 179 days (or for an indefinite period). Caution: The Pension Protection Act of 2006 allows certain individuals who participated in the Enron Corporation 401(k) plan to make special IRA catch-up contributions of up to $3,000 per year for tax years 2007 through 2009. Taxpayers who make these special contributions aren’t allowed to make age 50 catch-up contributions. Tip: The annual contribution limits ($5,000 in 2008, $4,000 in 2007) don’t apply to rollover contributions.

Q. If I have a large tax balance due next April because of my Roth IRA conversion, will I be able to avoid the underpayment penalties related to estimated taxes?

A. No. There is no exception to the underpayment penalty just because the balance due was caused by a Roth IRA conversion. There are other exceptions to the underpayment penalty that you might want to review that may allow you to dodge the penalty, but there is no “safe harbor” simply because the underpayment was caused by a Roth IRA conversion.

Q. I’m retired and drawing Social Security. Can I contribute part of my Social Security benefits to a Roth IRA account?

A. Nope — sorry. To make a Roth IRA contribution, you must have earned income. Earned income is generally income you receive from working — as compensation for your labor in one form or another. It’s reported to you on a W-2 form, or you report it on Schedule C (Business Income) or Schedule F (Farm Income) with your normal tax return. Earned income generally does not include Social Security benefits, pensions, interest, dividends, rental income, or capital gains.

Q. When I convert my regular IRA to a Roth IRA, do I have to pay the taxes all at once?

A. ‘Fraid so. You’re required to report the entire conversion income in the year of conversion. For conversions occurring in 1998, the income could have been spread out over several years… but that option is no longer available.

Q. If I convert my IRA to a Roth IRA, will that income increase my adjusted gross income for the current year?

A. Absolutely. The income you have to report for an IRA conversion to a Roth IRA will have an impact on any and all tax issues that are based on AGI — except for any Roth contribution and/or conversion issues. (In other words, if you meet the AGI limitation rules to convert or contribute to a Roth before taking the conversion income into consideration, this income won’t make you ineligible based on an increased AGI.) But, any tax provisions that use AGI as a guidepost will be affected — including medical expenses (7.5% AGI floor), miscellaneous deductions (2% AGI floor), taxability of Social Security (based on AGI), passive loss limitations (based on AGI), and many others.

In some cases, your AGI may be severely affected. This must be taken into consideration when you decide to make a Roth IRA conversion.

Q. I want to contribute to my Roth IRA, but my custodian says that I can’t put annual contributions into an account that has been converted. Is this true? And, if so, what should I do?

A. There’s no legal reason for you to separate your contribution and conversion funds into separate accounts. Under the old Roth IRA rules, contributions and conversions had different five-tax-year start times depending on conversion and/or contribution dates. Because of these staggered start times, the IRS suggested that contributions and conversions be maintained in separate Roth IRA accounts. That suggestion was made to the various financial institutions, and the institutions passed that information on to their clients.

But, with the changes made to the Roth IRA rules by the Tax Reform Act of 1998, the need for these separate accounts has been negated. It is now acceptable to commingle your Roth IRA conversions and contributions. While there are still staggered start times for contributions vs. conversions, the rules surrounding those start times are much clearer. So, having conversions and contributions in the same account, while still tricky, aren’t impossible to deal with. So, if your broker still insists that you separate your conversion funds and contribution funds, make sure to tell him or her of the new law that removed the segregation restrictions. And, if that doesn’t work, consider finding a new broker.

Roth IRA Questions

Q. My daughter is 16 years old. Can she make a Roth IRA contribution?

A. Age is not a determining factor. As long as your daughter has earned income with which to open the Roth IRA account, and as long as she is under the AGI limitations, she can make an IRA contribution regardless of her age.

Q. My father is 73 years old. Can he convert his regular IRA to a Roth IRA?

A. As noted above, age is not a determining factor. If your dad’s AGI is less than the $100,000 limitation, he’s eligible to make the conversion. Beware, though, that your father is in the period of minimum required distributions (MRD) from his traditional IRA. Therefore, before he converts that regular IRA to a Roth, he must receive his MRD for that year. Whatever that amount is, it cannot be transferred to the Roth.