Roth IRA

The Roth IRA is perhaps the premier individual retirement planning tool and savings account offered today.  In this article we're going to discuss the full range of Roth IRA benefits, the basics of withdrawals, transfers, and contributions.  Then we'll finish up with some comparisons between the Roth IRA and employer sponsored plans such as the 401k and 403b.

Roth IRA Benefits

Unlike traditional IRAs, the Roth IRA provides no federal income tax deduction for contributions.  However, it does provide benefits that aren't found in any other retirement plan - tax-free withdrawal of all earnings and principal.

Roth IRA Distributions

Another nice feature of the Roth IRA is related to minimum distributions.  Unlike other retirement vehicles, you are not required to take distributions from your Roth IRA at any age.  The "normal" or qualified distributions occur after age 59 1/2 and the plan has to be in existence - starting with the date you first contributed to a Roth - for at least five years.

There are also several qualified distributions, or withdrawal exceptions, that can be made from a Roth IRA before the age of 59 1/2 - as long as the plan has been in existence for at least 5 years.  If so, qualified distributions include:

• Distributions made because you have become disabled.
• Distributions made to your beneficiary of your estate.
• Up to $10,000 can be withdrawn to pay for a new home or rebuild a new home.

For more information on this topic, take a look at our article on IRA withdrawals.

Roth IRA Eligibility

And unlike traditional IRAs, there is no age limit for Roth IRA contributions.  There are however, income or compensation limits that will determine how much you can contribute to a Roth IRA.  In 2007 and 2008, you're eligible to contribute to a Roth IRA as long as your adjusted gross income (AGI) meets the following requirements:

• For married couples filing jointly, your AGI must be less than $166,000.
• For married couples filing separately the AGI limit is $10,000.
• If your filing status is Single, Head of Household or Married Filing Separately (and you do not live with your spouse in that tax year), then the AGI limit is $114,000.

The above compensation limits apply to full or what are called phase-out contribution limits.  For more detail on this topic, take a look at our article on IRA Contribution Limits.

Roth IRA Contribution Rules

In 2007 you can contribute up to $4,000 ($4,500 if you are 50 or older) to a Roth IRA, less all contributions made to other IRA plans.  In 2008, you can contribute up to $5,000 or $6,000 if you are 50 or older.  That's because the Roth IRA also allows for a catch-up contribution for those that meet the 50 or older age test.

Your spouse can also make contributions to a Roth IRA as long as the above income limits are not exceeded.  You can make your contribution to a Roth IRA anytime during the year up until the due date for your return for that tax year - which is usually around April 15th.

Current information for contributions, as well as catch up contributions and income limits appear in the tables below:

Roth IRA Contribution Limits (2006, 2007, 2008)

Roth IRA Income Limits

Roth IRA Conversions and Rollovers

When Roth IRAs were first introduced, there was a great deal of interest in converting a traditional IRA to a Roth IRA.  Generally, there three ways that you can convert a traditional to a Roth IRAs:

• Rollovers - an IRA rollover is simply an eligible distribution from a traditional IRA that is rolled-over into a Roth IRA within 60 days after the distribution.
• Same-Trustee Transfers - if your IRA trustee for the traditional IRA is the same trustee as the Roth IRA, then that trustee can make the account transfer on your behalf.
• Trustee-to-Trustee Transfers - many times your traditional IRA trustee will make a transfer to your new Roth IRA trustee on your behalf - even if they are not the trustee receiving the funds.

If you take a distribution from a traditional IRA, then the 60-day rollover rule applies.  If at all possible, you should covert your Roth IRA using a trustee-to-trustee transfer or same-trustee transfer.  This helps you steer clear of the 60-day rule.

Conversion Income Limits

If you want to covert from a traditional IRA to a Roth IRA, then your adjusted gross income or AGI cannot be greater than $100,000.  This conversion limit applies to taxpayers with filing statuses of single, head of household, and married filing jointly.  Married taxpayers filing separate returns are explicitly excluded from making Roth conversions.

Just be aware that converting to a Roth IRA means you may have to pay additional income taxes on the money converted.  For more information on this topic, take a look at our detailed article on Roth IRA Conversions.

Roth IRAs versus Other Retirement Savings Plans

So now that you understand a little bit about Roth IRAs, you might be wondering which option is best for you - Roth IRA, traditional IRA, or even a 401k plan if it's offered at work.  Everyone's situation is a little different, but here are some general rules that you can use:

• Roth IRA or 401k plans - If your employer offers a 401k plan, then chances are that the employer is also matching your contributions.  If you can afford to do so, you are probably best off to maximize your contributions that are matched before any money goes towards a Roth IRA.  You get an instant return on your investment when your employer matches your contribution.  We've discussed 401k contribution limits in an earlier article.
• Roth IRA or Traditional IRA - Traditional IRAs provide instant tax relief (contributions are tax deductible), but you will have to pay tax on all monies withdrawn.  Roth IRAs are not tax deductible, but all monies withdrawn are not subject to federal taxes.  If you have ten plus years before retirement, your investment in a Roth IRA should grow to such a degree that you are entitled to a larger tax benefit upon withdrawal relative to the early tax benefit of a traditional IRA.

There are arguments against this last statement, especially if you are in a high tax bracket now (traditional IRAs would give you a larger benefit today) and expect to be in a lower tax bracket in retirement (diminishing the tax benefit of a Roth IRA).  But remember, these are simple rules of thumb.  It's always a good idea to seek out the assistance of a professional tax advisor if you think your situation warrants making a change.

If you'd like more detailed information on this particular subject, take a look at our articles on Roth versus a Traditional IRA and Roth versus a 403b which provide some illustrative examples that also apply to 401k plans.

Funding a Roth IRA

As we mentioned in the beginning of this article, we believe that the Roth IRA is one of the best retirement savings plans offered today.  And while it's certainly important to understand all of the rules and policies established for Roth IRAs, it's also important to understand if you retirement funding plan is working.  To help answer that question, we've got some free retirement tools that you can use:

• Retirement Calculators - at last count we've got over 15 different retirement calculators to choose from including one dedicated to Roth IRA funding and another that can help you choose between a Roth and Traditional IRA.
• Retirement Guide - we've also got a retirement guide that can help you decide between Roth IRAs and 401k plans.
  

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