Roth IRA Help
Ensuring financial security in retirement is one of the greatest challenges facing American workers today. Concern regarding the long term viability of Social Security continues to grow, and Americans are looking for new ways to secure their financial future. The following trends show the importance of saving for retirement.
- Individuals are changing jobs more frequently, which might reduce their chance of acquiring great reserves in company pension plans.
- Many new entrepreneurs striking out on their own cannot offer retirement options for themselves or to their employees until the company is more financially secure.
- Social Security is no longer seen as the answer to retirement funding.
Individuals need to take responsibility to build their retirement nest egg. The Roth IRA allows individuals to invest after-tax dollars today, and let the assets grow with the potential to distribute the principal and earnings tax- and penalty-free during retirement.
Imagine for a moment that an individual has just received a check. She looks at her summary and notices that federal income taxes were not withheld. Her initial reaction is that something is wrong—it's not—if this check is from her Roth IRA.
Two factors make this possible.
- First, the money an individual contributes to a Roth IRA has already been taxed (individuals cannot take a tax deduction for their Roth IRA contributions). So the principal amount is never subject to future taxes or penalties as long as individuals stay within the contribution guidelines.
- Second, the Roth IRA allows contributions to grow tax-deferred. If an individual does not distribute any of the earnings until he has had the Roth IRA for at least five years and has a qualifying event (generally turning age 59½), those tax-deferred earnings are tax-free.
Unlike the Traditional IRA, there is no 70½ age limit on making contributions. But individuals must have eligible compensation, which is defined the same as for Traditional IRAs. As long as an individual satisfies the Roth IRA requirements, she may contribute to a Roth IRA, even after the year in which she attains age 70½.
The annual regular contribution limit is the lesser of $5,500 for 2015 and for 2016 (plus catch-up contributions, if eligible) or 100 percent of eligible compensation (generally earned income). IRA owners age 50 or older by the end of the tax year may increase their IRA contributions to help "catch-up" on their retirement savings, for a maximum contribution of $6,500 for 2015 and for 2016. The contribution limit applies to all Traditional and Roth IRA contributions made for the year, in aggregate.
Roth IRA contribution eligibility depends on the individual’s (or if married, the individual and the spouse’s) modified adjusted gross income (MAGI) and income tax filing status. The amount that an individual is eligible to contribute is reduced if his MAGI falls within or below certain phase-out ranges.
The 2015 and 2016 MAGI phase-out ranges are listed below.
|Filing Status||2015 MAGI||2016 MAGI|
|Married, Filling Joint||$183,000-$193,000||$184,000-$194,000|
|Married, Filing Separate||$0-$10,000||$0-$10,000|
The following specific details for Roth IRA contributions are based on 2016 figures.
- Single individuals with MAGI of $117,000 or less may contribute the maximum annual contribution ($5,500, plus catch-up contributions, if eligible) to their Roth IRAs.
- Single individuals with MAGI of more than $117,000 and less than $132,000 may make partial contributions to their Roth IRAs.
- Single individuals with MAGI of $132,000 or more may not contribute to Roth IRAs.
- Married individuals who file joint income tax returns with joint MAGI of $184,000 or less may contribute the maximum annual contribution to their Roth IRAs.
- Married individuals who file joint returns with joint MAGI of more than $184,000 and less than $194,000 may make partial contributions to their Roth IRAs.
- Married individuals who file joint returns with MAGI of $194,000 or more may not contribute to Roth IRAs for that year.
- Married individuals who file separate returns with MAGI of less than $10,000 may make partial contributions to their Roth IRAs.
- Married individuals who file separate returns with MAGI of $10,000 or more may not contribute to Roth IRAs.
Individuals must make regular contributions to Traditional and Roth IRAs by the due date of their federal income tax returns (generally April 15), not including extensions. If the deadline for filing an individual's income tax return falls on a Saturday, Sunday, or legal holiday, he will have until the following business day to make his contribution.
Contributions made between January 1 and April 15 of one year for the previous year are called prior-year contributions.
Individuals may take a qualified Roth IRA distribution tax- and penalty-free. A distribution of Roth IRA assets is considered a qualified distribution if two requirements are met. First, the Roth IRA must satisfy a five-year waiting period, beginning with the first day of the year for which the Roth IRA owner makes a regular contribution or, if earlier, in which the Roth IRA owner completes a conversion or retirement plan rollover. Second, the distribution must be made because of one of the following events.
- Age 59½
- First-time homebuyer
Distributions that meet the above requirements are referred to as "qualified distributions." While individuals may take distributions from their Roth IRAs at any time, distributions that are not qualified distributions may be subject to taxes (and in some cases the 10 percent early distribution penalty tax).
Yes. An individual may convert assets from a Traditional IRA to a Roth IRA. The individual must pay tax on any previously untaxed dollars converted from, but the 10 percent early distribution penalty tax does not apply to the conversion amount. Individuals should seek advice from a competent tax advisor to determine whether converting pretax retirement assets is beneficial.
For more information on conversions, see "Conversion From a Traditional IRA" under the Help section in the IRA Section Center.
Unlike Traditional IRAs, there are no required minimum distributions due upon attaining age 70½. Earnings can continue to grow tax-deferred until the Roth IRA owner takes a distribution. There are special distribution requirements, however, after the IRA owner dies.
Created by the Taxpayer Relief Act of 1997, a conversion is a taxable movement of assets from a Traditional IRA (including a Traditional IRA that holds simplified employee pension (SEP) plan contributions) or a savings incentive match plan for employees of small employers (SIMPLE) IRA to a Roth IRA. For a SIMPLE IRA, an individual must satisfy a two-year waiting period, which begins on the date the employer deposits the first SIMPLE IRA contribution, before she may convert SIMPLE IRA assets to a Roth IRA.
Certain individuals may roll over their employer-sponsored retirement plan assets to a Roth IRA. See "What is an employer-sponsored retirement plan-to-Roth IRA rollover?" for more information.
The difference between a Traditional and Roth IRA can be summarized by the following comparison.
|Traditional IRA:||Regular contributions may be tax-deductible|
|Roth IRA:||No deductions|
|Roth IRA:||Tax-free if used properly|
|Traditional IRA:||Includable in taxable income|
|Roth IRA:||Tax-free for qualified distributions|
The Tax Increase Prevention and Reconciliation Act of 2005 eliminated conversion eligibility requirements beginning January 1, 2010. Therefore, anyone may convert eligible assets in an existing IRA or roll over employer-sponsored retirement plan assets to a Roth IRA without having to meet any Roth IRA eligibility requirements.
Read "How much can I contribute to a Roth IRA?" to learn about the eligibility limits.
You must include in your gross income all pretax assets converted to a Roth IRA. You will not, however, be subject to the 10 percent early distribution penalty tax.
EXAMPLE:Oliver has only made deductible IRA contributions to his Traditional IRA. In 2016, Oliver decides to convert $20,500 from his Traditional IRA to a Roth IRA. Oliver will need to include $20,500 as income in 2016.
For any conversion made in 2010, the Tax Increase Prevention and Reconciliation Act of 2005 allowed the taxable amount of the conversion to be included in the taxpayer's gross income ratably in 2011 and 2012 unless he elected to include the entire taxable amount in 2010 income.
If you distribute conversion assets within five years of the conversion, a 10 percent early distribution penalty tax will apply unless you have a penalty tax exception.
The following factors may play a role in determining whether a conversion of Traditional IRA assets or a rollover of employer-sponsored retirement plan assets to a Roth IRA is the right choice for you.
- Anticipated tax rate at retirement
- Years until retirement
- Current tax rate
- Earning rate assumptions
- Distribution plans at retirement
For some individuals, there are significant tax saving opportunities provided by the Roth IRA conversion option. Conversion to a Roth IRA is not, however, right for everyone. Use the conversion calculator to gain a better understanding of how various assumptions can affect your decision.
Effective January 1, 2008, individuals may roll over pretax and after-tax employer-sponsored retirement plan assets to a Roth IRA. Individuals could roll over retirement plan assets only to other retirement plans or Traditional IRAs before January 1, 2008.
Like IRA conversions, if you roll over retirement plan assets to a Roth IRA (excluding designated Roth accounts in retirement plans), you must include the taxable portion of the distribution in your gross income. Once you roll over these assets to a Roth IRA, they continue to grow tax-deferred. If you meet the requirements for a qualified Roth IRA distribution, you may distribute the earnings tax-free. If you do not meet the requirements for a qualified Roth IRA distribution, you may owe tax or an IRS penalty tax on some or all of the assets.