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Roth IRA Rules

Roth IRA rules are fairly straightforward, and they align with many of the retirement planning scenarios that an investor might encounter over time: eligibility, contributions, transfers, and withdrawals.  Fortunately, this relatively short list covers most of the Roth IRA information individuals would ever need to understand.

Roth IRAs and Retirement

Let's start by making sure everyone knows exactly what a Roth IRA is used for, and then we'll review each of these rules by category.  A Roth IRA is just one of several types of Individual Retirement Accounts.  There are also Traditional IRAs, and SIMPLE IRAs, which have slightly different advantages or groups they target, but they really all serve the same purpose.  An individual retirement account is a way that a person can put money aside for retirement.

Additional Resources

Since all of these retirement accounts have both short-term and long-term tax implications, the Internal Revenue Service has outlined several guidelines to make sure abuses do not take place.  As will be soon demonstrated, some of these rules are there to protect the investor, while others are there to protect the government; so let's get started.

Eligibility

Anyone can contribute to a Roth IRA, regardless of age.  The only eligibility requirement for a Roth IRA contribution is taxable compensation, which includes salaries, wages, tips, bonuses, fees, and any other amount they've received for providing a service to others.  Even if someone's eligible to contribute to a Roth IRA, there are limits to those contributions.

Compensation

To be eligible for a Roth IRA contribution in a given calendar year the individual needs some form of compensation.  There is also an income limit on contributions.  If their modified adjusted gross income exceeds these limits, they are no longer eligible to contribute to a Roth IRA.

In 2014, the modified adjusted gross income limits are:

  • Single filers, Head of Household, or Married Filing Separately (and they did not live with their spouse during the year), with modified adjusted gross income up to $114,000 can make a full contribution.  Contributions are phased out starting at $114,000, and taxpayers cannot make a deposit if their modified adjusted gross income is in excess of $129,000.
  • Joint filers with modified adjusted gross income up to $181,000 can make a full contribution.  Once again, this contribution is phased out starting at $181,000 and taxpayers cannot make a deposit if their modified adjusted gross income is in excess of $191,000.
  • Taxpayers with a filing status of Married Filing Separately (and living with their spouse) cannot make a Roth IRA contribution if their AGI is in excess of $10,000.

In 2013, the modified adjusted gross income limits are:

  • Single filers, Head of Household, or Married Filing Separately (and they did not live with their spouse during the year), with modified adjusted gross income up to $112,000 can make a full contribution.  Contributions are phased out starting at $112,000, and taxpayers cannot make a deposit if their modified adjusted gross income is in excess of $127,000.
  • Joint filers with modified adjusted gross income up to $178,000 can make a full contribution.  Once again, this contribution is phased out starting at $178,000 and taxpayers cannot make a deposit if their modified adjusted gross income is in excess of $188,000.
  • Taxpayers with a filing status of Married Filing Separately (and living with their spouse) cannot make a Roth IRA contribution if their AGI is in excess of $10,000.

Once a taxpayer knows they can fund an account, the next logical question is:  How much can I contribute to a Roth IRA?  That question brings us to the third set of rules.

Contributions

The IRS has established a set of guidelines that govern the contributions to Roth IRA accounts.  The following table outlines those allowable contributions for the years 2006 through 2014:

Tax Year Contribution Limit Limit with Catch-Up
2006 to 2007 $4,000 $5,000
2008 to 2012 $5,000 $6,000
2013 $5,500 $6,500
2014 $5,500 $6,500
2015 Indexed to Inflation Indexed to Inflation

Note:  The 2015 information should be available in the mid to late October 2014 timeframe.

Catch-Up Contributions

To help workers age 50 and over, the IRS has a subset of contribution rules that apply only to individuals age 50 and over by the end of a calendar year.  These are called catch-up contributions.  The table above outlines the limits that apply to workers age 50 and over.

Transfers and Rollovers

These final two Roth IRA rules have to do with access to money in the account.  The first of which we are going to discuss are transfers, or what is sometimes called an IRA rollover.  Accountholders can transfer a Traditional or a SIMPLE IRA to a Roth in several different ways:

  • Account-to-Account:  includes asking the trustee or custodian of the Traditional IRA to transfer the funds to another institution that is managing the Roth IRA.
  • Same-Trustee:  consists of converting a Traditional IRA to a Roth account within the same financial institution, or simply re-designating the IRA as a Roth.
  • Rollover:  taking a distribution from a Traditional IRA and moving it into a Roth within 60 days of receiving the distribution.

If, for some reason, the transfer or conversion fails, the accountholder may be subject to early withdrawal penalties such as a 10% additional tax.  For more information on this important topic, take a look at our article: IRA Rollovers.

Distributions / Withdrawals

The final rule we're going to discuss has to do with withdrawals, or distributions.  Here there are two forms of distributions from a Roth IRA: qualified distributions and early distributions.  A qualified distribution is one that happens five years after the accountholder first started to contribute to a Roth IRA, and they've reached age 59 1/2.  A qualified distribution would be a "normal" distribution of funds from the account.

Early withdrawals are normally subjected to a 10% additional tax penalty.  Fortunately, the IRS has made some exceptions to the 10% tax penalty.  Generally, if the accountholder is disabled, a first time homeowner, or if they are using the money to pay for higher education expenses, they are exempt from the tax penalty.  There are several more exemptions to the 10% penalty, which are covered in more detail in our article on IRA Withdrawals.


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