Roth IRA

Qualified distributions are completely tax free A withdrawal from a Roth IRA (including both contributions and investment earnings) is completely tax free (and penalty free) if (1) made at least five years after you first establish any Roth IRA, and (2) one of the following also applies:

You have reached age 59½ by the time of the withdrawal The withdrawal is made due to qualifying disability The withdrawal is made for first-time homebuyer expenses ($10,000 lifetime limit) The withdrawal is made by your beneficiary or estate after your death Withdrawals that meet these conditions are referred to as qualified distributions. If the above conditions aren’t met, any portion of a withdrawal that represents investment earnings will be subject to federal income tax and may also be subject to a 10 percent premature distribution tax if you are under age 59½. See Questions & Answers.

Tip: The five-year holding period begins on January 1 of the tax year in which you make your first contribution (regular or rollover) to any Roth IRA. Each taxpayer has only one five-year holding period for this purpose. Tip: Because the 5-year holding period runs from the first day of the plan year in which you establish any Roth IRA you should establish one as soon as you can, even if you can afford only a minimal contribution. The earlier you satisfy the 5-year holding period, the sooner you may be able to receive tax-free qualified distributions from your Roth IRA.

Fewer restrictions on making withdrawals prior to retirement The ability to make tax-free withdrawals from a Roth IRA under certain conditions (”qualified distributions”) can be a compelling reason to use this type of IRA. Furthermore, even if you make a withdrawal that fails to meet those conditions (a “nonqualified” distribution), you may not be taxed on the full amount of the withdrawal. That’s because when you withdraw funds from your Roth IRA, distributions are treated as consisting of your contributions first and investment earnings last. Since amounts that represent your contributions have already been taxed, they are not taxed again or penalized (even if you are under age 59½) when you withdraw them from the Roth IRA. Only the portion of a nonqualified distribution that represents investment earnings will be taxed and possibly penalized.

Caution: If you convert funds from a traditional IRA to a Roth IRA, special penalty provisions may apply if you subsequently withdraw funds from the IRA within five years of the conversion (and prior to age 59½).

You can contribute to a Roth IRA after age 70½ Unlike traditional IRAs, you can contribute to a Roth IRA for every year that you have taxable compensation, including the year in which you reach age 70½ and every year thereafter.

Your funds can stay in a Roth IRA longer than in a traditional IRA The IRS requires you to take annual required minimum distributions from traditional IRAs beginning when you reach age 70½. These withdrawals are calculated to dispose of all of the money in the traditional IRA over a given period of time. Roth IRAs are not subject to the required minimum distribution rule. In fact, you are not required to take a single distribution from a Roth IRA during your life (although distributions are generally required after your death). This can be a significant advantage in terms of your estate planning.

You can contribute even if covered by an employer-sponsored retirement plan Unlike a traditional IRA where you make deductible contributions, your ability to contribute to a Roth IRA (or to make nondeductible contributions to a traditional IRA) does not depend on whether you or your spouse is covered by an employer-sponsored retirement plan. The fact that one of you is covered by such a plan has no bearing on your allowable contribution to a Roth IRA. However, remember that your ability to contribute to a Roth IRA does depend on your tax filing status and MAGI for the year.

Investment choices are broad and diverse Like a traditional IRA, you can establish a Roth IRA with a bank, mutual fund company, life insurance company, or stockbroker. You can even have multiple IRA accounts with more than one institution. Furthermore, you can choose from a wide range of specific investments to fund your Roth IRA. Intense competition for IRA dollars has led to a large number of IRA providers and investment choices.

Caution: The IRS has ruled that the wash sales rules apply if you sell stock or other securities outside of your IRA for a loss, and purchase substantially identical stock or securities in your IRA (traditional or Roth) within 30 days before or after the sale. The result is that you cannot take a deduction for your loss on the sale of the stock or securities. In addition, your basis in your IRA is not increased by the amount of the disallowed loss.

When you die, your beneficiaries may pay no income tax on proceeds As long as any Roth IRA you have established has been in existence for at least five years at the time of your death, your beneficiaries will not have to pay any federal income tax on post-death distributions from any Roth IRA you own. Even if you haven’t satisfied the five-year holding period at the time of your death, distributions to your beneficiary will still be tax free if he or she waits until the date you would have satisfied the five-year holding period before taking distributions from the Roth IRA. Tax-free distributions to your beneficiarycan make the Roth IRA a very valuable estate planning tool. However, bear in mind that the value of your Roth IRA will be included in your taxable estate to determine if federal estate tax is due.

Caution: The five-year holding period applies independently to Roth IRAs you hold as a beneficiary, and Roth IRAs you hold as your own. If your sole beneficiary is your surviving spouse, and your spouse treats your Roth IRA as his or her own when you die, then distributions from the Roth IRA will be tax-free only if your spouse satisfies the requirements for a qualified distribution (that is, your spouse satisfies the five-year holding period, and the distribution is made after your spouse attains age 59½, becomes disabled, dies, or incurs qualifying first-time homebuyer expenses). The five-year holding period–for both the inherited IRA and any other Roth IRAs your spouse may own–ends on the earlier of (a) the end of your five-year holding period, or (b) the end of the five-year holding period applicable to your spouse’s own Roth IRAs.

Contributions are discretionary Like a traditional IRA, you do not have to make a contribution to your Roth IRA for any year unless you choose to. Within the limits on the amount that you can contribute each year, you can exercise complete discretion in deciding how much and when to save.

A Roth IRA is relatively simple to maintain Like a traditional IRA with deductible contributions, a Roth IRA is relatively simple to maintain. There are no annual reporting requirements for Roth IRAs.

Traditional IRAs can be converted to Roth IRAs If you qualify, you can convert your traditional IRA funds to a Roth IRA. This may be advisable if you have determined that you will reap more benefits from the Roth IRA than the traditional IRA. In general, you qualify if you (a) don’t file your federal income tax as married filing separately, and (b) your modified adjusted gross income (whether you are single or married filing jointly) is $100,000 or less. (These restricitons are repealed for tax years after 2009.) However, you should carefully consider the income tax consequences and other issues associated with converting funds. See Converting or Rolling Over Traditional IRAs to Roth IRAs for a detailed discussion.

“Catch-up” contributions are allowed if you’re at least 50 Individuals age 50 and older may make an additional yearly “catch-up” contribution up to $1,000 to a traditional or Roth IRA (over and above the regular contribution limit). The purpose of this provision is to help older individuals increase their savings as they approach retirement.

You may qualify for a tax credit Certain low- and middle-income taxpayers can claim a partial, nonrefundable income tax credit for amounts contributed to a traditional or Roth IRA. The maximum annual contribution eligible for the credit is $2,000. The maximum credit is $1,000 (50 percent of $2,000) per taxpayer, but the actual amount of the credit (if any) depends on your MAGI. Only joint returns with an MAGI of $53,000 or less, head-of-household returns of $39,750 or less, and single (including married filing separately and qualifying widow/widower) returns of $26,500 or less are eligible for the credit (these income limits are adjusted for inflation). Here are the credit rates based on 2008 MAGI limits:

To claim the credit, you must be at least 18 years old and not a full-time student or a dependent on another taxpayer’s return. The credit is in addition to any income tax deduction you might qualify for with respect to your IRA contribution.

Caution: The amount of any contribution eligible for the credit may be reduced by any taxable distributions you (or your spouse if you file a joint return) receive from an IRA or employer-sponsored retirement plan (or any nontaxable distributions from a Roth IRA) during the same tax year, during the period for filing your tax return for that year (including extensions), or during the prior two years.