Roth IRA in a Nutshell
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Roth IRATax free earnings are probably the most popular feature of Roth Individual Retirement Accounts. Roth IRA’s were established under the Taxpayer Relief Act of 1997. Since then they’ve continued to grow in popularity. Everyone is not eligible to participate in a Roth IRA due to the strict requirements. Eligibility and contribution limits are determined by MAGI or Modified Adjusted Gross Income.
Adjusted Gross Income is found on line 37 of the individual tax return. It includes all income earned, losses incurred and any deductions or credits allowed. To determine the MAGI start with the figure on line 37 and adds back certain items such as foreign income, foreign-housing deductions, student-loan deductions, IRA-contribution deductions and higher-education costs. A high MAGI reduces the amount of the IRA contribution. It can even go down to zero. If this happens, one can still contribute to the Roth IRA but taxes will apply.
For the individual filing as ’single’, his or her income must not exceed $116,000. They may contribute up to $5,000 plus a catch-up amount with income less than $101,000. For individuals with MAGI between $101,000 and $116,000, the contribution limit is phased out. The amount they can contribute is determined by a certain formula.
For individuals filing ‘married filing jointly’, the combined MAGI for both should not exceed $169,000. Each spouse can contribute up to $5,000 plus a catch-up amount if their combined MAGI is not more than $159,000. If their income is between $159,000 and $169,000, the contribution limit is phased out.
For individuals filing ‘married filing separately’, his or her MAGI must not exceed $10,000. If the income is between $0 and $10,000, the contribution limit is phased out.
The experts recommend that you still contribute to a Roth IRA even if you fall within the phase out range. Studies show, in most cases, that the benefit of funding the Roth IRA, at any amount, outweighs the benefits of funding a Traditional IRA. They also recommend opening a ROTH IRA as young as possible so your investment has longer to earn money.
Distributions from a Roth IRA may be tax free if you meet the following guidelines:
1. The distribution must occur at least five years after the Roth IRA was opened and funded.
2. In addition to this you must also meet one of the following: the owner of the Roth IRA must be at least 59.5 years of age when the distribution occurs, $10,000 can be withdrawn if used towards the purchase of a first home, disabled Roth IRA holders can make distributions or funds can be distributed to beneficiaries after the death of the Roth IRA holder.
The Roth IRA is an excellent way to save for retirement. But it’s not for everyone. Before making a decision, do your homework and seek the advice of professionals if unsure.
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30 May 2008, 1:37 pm
There is an important set of questions to consider before depositing to a Roth:
Current tax bracket
Availability of matched 401(k) funds
Potential future bracket
Potential (shorter term) future disruptions of employment or income level.
You see, it takes quite a bit of saved money to hit the higher brackets. A sum most will never achieve. So the couple in the 28% bracket need well over $3,000,000 in pretax money before risking the withdrawals be at over 25% at withdrawal. Most of their money will come out at 0%, 10%, 15%. Any year of low income along the way is an opportunity to convert to Roth if they fall into a lower bracket.
Joe