The
Roth Individual Retirement Account represents a major new form of retirement savings
that should not be overlooked. Created by the Taxpayer Relief Act of 1997, enhanced
by 1998 tax legislation, interpreted by recent IRS and Treasury Department rules
in 1999 and 2000, and improved by the Tax Relief Reconciliation
Act of 2001, the Roth IRA offers a unique opportunity for tax-free accumulation
and withdrawal of retirement funds. Unlike conventional IRAs, contributions to
these new IRAs are not deductible. Also unlike conventional IRAs, qualified distributions
from Roth IRAs are subject to neither income tax nor a penalty for early withdrawal.
The maximum yearly
contribution an individual can make to all of his or her IRAs is $5,000 in 2008. In addition, annual "catch-up"
additions to an IRA could be made by those age 50 or older, in the amount of $1,000 for 2008. But these limitations do not
apply to rollovers or conversions of existing IRAs into a Roth IRA. The maximum
contribution to a Roth IRA phases out for joint filers with modified adjusted
gross income (MAGI) between $159,000 and $169,000, and individuals with MAGI between
$101,000 and $116,000.
If
you already have an IRA, you may be able to roll it over or convert it into a
Roth IRA. You cannot do this, however, if your modified adjusted gross income
for the tax year exceeds $100,000 (determined before any amount is included in
income as a result of the rollover) or you are married filing separately (unless
you have lived apart from your spouse for the entire year).
Unlike
rollovers from a conventional IRA to another conventional IRA, you must pay income
tax on the amount that would have been included in gross income if you had taken
the rollover amount as a distribution. There are also complicated rules if you
use some of the conversion amount to pay the income tax due, or if you receive
another distribution before a 5-year period expires.
Roth
IRAs can be more flexible than conventional IRAs. You do not have to start distributions
from a Roth IRA by April 1 of the calendar year you reach age 70-1/2; in fact,
you can continue to make contributions to a Roth IRA after age 70-1/2. This means
that if you expect to be financially comfortable in retirement, a Roth IRA possibly
could be an important estate-planning tool.
Some
of the more important IRS rules include:
ROTH
Conversion Rules
Regulations have been issued to add much-needed detail
to the rules for making a proper ROTH IRA conversion. For example, the regulations
clarify that the year in which a rollover conversion takes place is the year funds
are withdrawn from a traditional IRA, not when they are deposited into the ROTH
IRA.
Roth
Recharacterization Rules
Although
originally intended to rescue only those who mistakenly convert a Roth IRA, the
proposed regulations can also be applied to allow recharacterization of Roth IRA
accounts that have decreased in value during the tax year of the conversion. As
a result, a taxpayer who would be paying income taxes on a Roth IRA conversion
at a value-at-conversion, which is much higher than its value at the time taxes
are due, should consider reconverting back into a traditional IRA, tax free. Under
regulations adopted in 2000, the reconversion cannot be made until the year following
the original conversion. If you then decide to convert back to a Roth IRA, you
must wait another 30 days.
Distribution
Priorities
One important advantage a Roth IRA offers is the ability to
withdraw amounts tax free in "qualified distribution" situations. In
planning multiple-year Roth IRA contributions, regulations allow favorable computation
of the critical five-year waiting period rule for withdrawals. They also give
taxpayers precise guidelines, using detailed aggregation and ordering rules, on
how much of a Roth IRA withdrawal will be taxed, and under what circumstances.
It is sometimes advantageous to maintain a mix of IRAs. Determining whether to open a Roth IRA is sometimes complex. It can involve, among other factors, a look at your present tax bracket and your likely tax bracket at retirement, whether immediate deductions for your contributions are more beneficial than the potentially tax-free distributions from a Roth IRA, and how close you are to retirement.
If you would like any further information regarding this issue as well as any other tax related issue, please contact The Henssler Financial Group Tax & Accounting Division at 770-428-4025.
