Dan Hall & Associates Solid Plans for Peace of Mind

Roth IRAs

Overview

A Roth IRA is an individual retirement plan; it can be either an account or an annuity.  A Roth IRA is similar to a traditional IRA, except for the following differences.

A Roth IRA can be set up and contributed to at any time in the individual’s life, while a traditional IRA can only be contributed to before age 70.5.  The contributions made to a Roth IRA are also not tax deductible.  However, the distributions from the Roth IRA are tax free, as long as the distributions are made at least five years after the first contribution to the Roth IRA was made, and as long as the payment or distribution is made on or after you reach age 59.5.  The distributions may be made at an earlier age if you are disabled; however, the five year waiting period still applies.  The distributions may also be made to a beneficiary or to your estate after your death, although the five year waiting period applies to this as well.  Furthermore, if you are the original owner of the Roth IRA, you are never required to take contributions, unlike a traditional IRA, which requires you to take contributions after you turn 70.5.

Rules for Contributions

Unlike traditional IRAs, contributions made to a Roth IRA are not tax deductible.  However, there is no age limit on making contributions to a Roth IRA; they can be made at any point in the contributor’s lifetime.  For a given year, contributions can be made any time during that year, or by the due date of your tax return for that year, not including extensions.

In order to contribute, you must have taxable compensation (meaning: wages, salaries, tips, professional fees, bonuses, etc.), and a modified adjusted gross income (AGI) of less than:

  • $194,000 for married couples filing jointly or a qualifying widower;
  • $132,000 for a single or head of household;
  • or $10,000 for a married couple filing separately.  (Amounts based on 2016 limitations)

If you are only contributing to Roth IRAs, the combined maximum contribution allowed per year is the lesser of either $5,500 ($6,500 if you are age 50 or over), or your taxable compensation.  If you are contributing to Roth IRAs and traditional IRAs, your maximum annual allowed contribution is the same as above, minus all contributions made to a non-Roth IRA.  (So for example, if you are under age 50 and in one year contributed $3,000 to a traditional IRA, you would only be able to contribute $2,500 combined to your Roth IRAs in that same year.)

If you exceed the contribution limit, you must pay a 6% excise tax on all excess contributions.  However, if your contributions for one year are over the limit, you can apply the excess contribution to a later year if the contributions for that year are less than the maximum allowed for that year, and avoid paying the excise tax.

Conversions

It is possible to convert some or all of you assets in a traditional IRA to a Roth IRA.  There are three ways to do this:

  • The first is through a rollover: you can receive a distribution from a traditional IRA and contribute it (roll it over) to a Roth IRA within 60 days of the original distribution.
  • The second is through a trustee-to trustee transfer:  you can direct the trustee of the traditional IRA to transfer an amount from the traditional IRA to the trustee of your Roth IRA.
  • The third option is a same trustee transfer: if the same trustee oversees both your Roth and traditional IRAs, you can direct the trustee to transfer an amount from one to the other.

However, no matter the method used, amounts transferred or converted from a traditional IRA into a Roth IRA must be included in your gross income for the tax year in which the amount is distributed or transferred (except for the portion attributable to non-deductible contributions to the traditional IRA).  (For example, if you transfer $1,000 from a traditional IRA to a Roth IRA, you still have to include the $1,000 in your income on your tax return for that year.)

In addition, if you choose to convert only part of your traditional IRA, rather than the entire thing at once, you can’t choose to convert only the nontaxable part of your traditional IRA (which contains both taxable and nontaxable money).  So, if you have a traditional IRA with a balance of $10,000, $6,000 of which is in nondeductible contributions, and you choose to rollover or convert $6,000 of this money to a Roth IRA, you’re required to treat the rollover as coming 60% from the nondeductible contributions, and 40% from the tax deductible contributions.  Thus, 40% of that rollover money will be taxable.

Rollovers

You can also roll over all or part of a distribution you receive from your (or your deceased spouse’s) employer’s qualified pension, profit-sharing or stock bonus plan (including the 401k); an annuity or tax-sheltered annuity plan; or a governmental deferred compensation plan.  However, you must include in your gross income distributions that you would have had to include in your income if you had not rolled them over into a Roth IRA; you don’t have to include a distribution from a retirement plan that is a return of after-tax contributions that were taxable to you when paid.

There are two rollover methods.  One is to receive a distribution from a retirement plan and roll it over to a Roth IRA within 60 days of the distribution.  Since the distribution is paid directly to you, the payer generally has to withhold 20% of it.

There is also the direct rollover option, where an employer’s retirement plan gives the option to have any part of a distribution paid directly to a Roth IRA.  Since this is paid directly into the IRA, there is generally no withholding.  Rollovers from one Roth IRA to another Roth IRA are completely tax free, if the rollover is made within 60 days.

By Genevieve Hoffman 7/8/10; revised in 2016 to reflect changed limits

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