Roth IRA

Guide to Roth IRA

The following "Roth IRA" information is presented here so the average person can make sense and understand the difference between an IRA and a Roth IRA.

Basically a Roth IRA is an individual retirement plan that invests in securities, mostly common stocks or mutual funds. It is still subject to the rules that apply to a traditional IRA and there are specific eligibility and filing status requirements mandated by the I.R.S. The Roth IRA has been named after its primary legislative sponsor, Senator William Roth.

In order for it to be a legal Roth IRA account, it has to be designated as a Roth IRA when it is first opened. An IRA can be considered a Roth IRA, but the SEP-IRA and the SIMPLE IRA cannot be.

One major difference between a traditional IRA and a Roth IRA ia that contributions to a Roth IRA are not deductable. There are certain types of distributions that you may qualify for that are tax free.

One of the greatest advantage of the Roth IRA over other types of IRA's is its lack of forced distributions based on age. The Roth IRA is completely free of age mandates concerning withdrawals and you can leave amounts in your Roth IRA as long as you are alive.

The tax structure of a Roth IRA is another advantage over other types of IRA accounts. Payments to the fund are made from only the earned income that is already taxed, but distributions that equal or are below the total of the contributions are tax free. Often withdrawals of earnings are tax free too.

A traditional IRA contributions in contrast are tax deductible if certain requirements are met, but the money you take out is considered income and subject to tax. There are fewer restrictions and requirements on money withdrawn from the Roth IRA when compared to the traditional IRA. Both types offer tax free transactions inside the account, like capital gains, dividends, and normal interest, and both have limits on the total of contributions. The contributions may be split between your traditional IRAs and your Roth IRAs.

The Tax Increase Prevention and Reconciliation Act of 2005 was signed into law by President Bush on May 17, 2006. Part of this tax bill includes a provision that deals with conversions of traditional IRAs to Roth IRAs. The current $100,000 income test used to convert a traditional IRA to a Roth IRA will no longer apply after 2010. A conversion that is done in 2010 can have half of the converted amount be taxed in 2011 and the rest in 2012.

Roth IRA Calculator

There are tax advantages to both types of IRA's for saving for your retirement. Choosing which one you should set up and contribute to is sometimes the hardest decision. There are a number of factors that can help you determine which one is right for you, such as age, income, tax rate, and years left before you will need the money. The Roth IRA Calculator links below are intended to help you analyze which IRA is most advantageous for you.

MSN Money Roth IRA Calculator
http://moneycentral.msn.com/investor/calcs/n_roth/main.asp

Moneychimp.com Roth IRA Calculator
http://www.moneychimp.com/articles/rothira/rothcalc.htm

State Farm Roth IRA Calculator
http://www.statefarm.com/jscript/iracalc2.htm

Amica Roth IRA Calculator
http://www.amica.com/life_insurance/calcs/RothIRA.html

Ditech Roth IRA Calculator
http://www.ditech.com/calculators/ira.html

Roth IRA Contribution

The limit you can contribute to a Roth IRA is depends if you are paying into only the Roth IRA or into a traditional IRA as well. Below is a general guideline, so please consult your financial planner to be 100% acurate to your situation.

If you only contribute to a Roth, then your deposit limit is usually the lesser of:

$4,000 ($4,500 if you are age 50 or older; for 2006)
$4,000 or $5,000, if you are age 50 or older) or
Your taxable compensation

If you contribute to both types, then your deposit limit is usually the lesser of:

$4,000 or $4,500 if you are age 50 or older for 2006
$4,000 or $5,000 if you are age 50 or older minus all other contributions made
into other types IRA plans for the year (except employer paid)
Your taxable compensation minus all contributions

Roth IRA Limit

The has been a limit placed on who can contribute into a Roth IRA by Congress because of the tax advantages this type of IRA account offers. The established limit to who can utilize a Roth IRA is based upon your Modified Adjusted Gross Income.

See IRS "Publication 590" for more the current rate scale and other information concerning Roth IRA limits.

Roth VS Traditional IRA

As we have seen above and briefly went over above, there are advantages and disadvantages to each type of IRA. The biggest disadvantage of a Roth IRA over a traditional IRA is that can can't deduct contributions drom your taxes.

Disadvantages of a Roth IRA:
The main disadvantage of a Roth IRA (when compared to a traditional IRA) is that contributions are never tax-deductible. Early withdrawals of earnings are also subject to heavy penalties. Any withdrawal of earnings that is not qualified will result in federal income tax plus a 10% early withdrawl penalty. There are many qualified exceptions, such as for education or a first home.

Advantages of a Roth IRA:
As long as a taxpayer has earned income and is still within the limits of the modified AGI, you can make contributions into a Roth IRA with no age restrictions. The total of contributions may be withdrawn at any time by the IRA owner.

Unqualified withdrawls of more than the total of contributions with seasoned conversions are deemed earnings withdrawls and are subject to tax. As long as the account has been established for five or more years then earnings withdrawn are qualified automatically the year the account owner reaches 59 1/2 or becomes disabled. If the withdrawn money is used to buy a principal residence, then up to $10,000 in earnings can be considered qualified.

When the owner of a Roth IRA passes away the surving spouse becomes the beneficiary of that Roth IRA and they may combine their Roth IRA with there departed spouses without penalty. See IRS "Publication 590" for more information on qualified distributions that are available to the beneficiaries of Roth IRA account owners.

The lack of forced distributions based on age is one of the best advantages of the Roth IRA over a traditional IRA. All other tax free retirement plans mandate that at age 70 1/2 that disbursement of funds begin and there is a minimum of annual withdrawls once they begin beyond the age of 59 1/2. The Roth IRA is totally free of these restrictions.

Roth 401k

The Roth 401k bill was passed by Congress in 2001 and went into effect on 1/1/2006. Unless it is extended by legislative action, it will only be available until 12/31/10. The new Roth Roth 401(k) is a combination of traditional 401(k) features with those of the Roth IRA. Like a regular 401(k) plan, employers will offer this "after-tax dollars" contribution plan. Although the account doesn't offer immediate tax-deductions, it will will grow tax-free and money withdrawn during retirement will not be taxed as income. You must have the account for five years and be at least 59 1/2.

The Roth 401(k) could end sooner then 12/31/10 though if the proposed President's Advisory Panel on Federal Tax Reform changes to pension and savings plans go into effect sooner. With the President's proposed "Save at Work" Income Tax Plan would be the replacement to 401k plans. This plan would have the same contribution limits and rules as the current 401k's, but the rules for qualification would be simplified. In addition, "Save for Retirement" accounts, which are essentially a Roth IRA, would replace IRAs and Roth IRAs with $10,000 per year contribution limits. if this does happen, the balance of your Roth 401(k) would be able to be rolled over to the new account type. So far these are only proposed changes and haven't gone into effect yet.

The Roth 401(k) became active as of January 1, 2006, but there a few companies currently offering their employees the Roth 401k alternative. This is expected to change over time though.